Energy companies under pump as oil sinks to $US25
Australia’s energy producers hit the panic button this week as oil plunged to a two-decade low teetering just above $US25 a barrel.
Australia’s energy producers hit the panic button this week.
As oil plunged to a two-decade low teetering just above $US25 a barrel, companies scheduled a series of emergency meetings with banks.
The industry had taken a battering with share prices off 70 per cent since January as investors questioned whether high debt and potential covenant breaches could tip the sector underwater.
Oil Search – juggling $US3.4bn in debt and market rumours over its ability to remain within thresholds agreed with its creditors – was the first to move after slashing 40 per cent of its spending this year.
Its new boss Keiran Wulff has been in the job for less than a month after taking over from long-serving chief Peter Botten.
But critically he had valuable experience dealing with an oil price crash.
Botten assigned Wulff the job of restructuring Oil Search during the last big crude plunge in 2015 when prices hit a low of $US26 a barrel.
Five years on in what Wulff this week described as “unprecedented times”, the focus was first on gaining comfort with its banks and then holding several days of meetings with shareholders after outlining its cost cutting targets.
Oil Search’s main $US440m corporate facility requires an earnings to interest ratio of more than three times which is calculated on a six-month basis over the previous year.
Most of its earnings are tied to LNG which typically takes up to three months to reflect crude price swings meaning the full impact of current conditions may not be felt until June.
Crucially, many of its long-term lenders indicated during phone hook-up meetings this week they would be prepared to waive covenants until the end of the year if required.
“If $US25 oil is here for the rest of the year, there will need to be some give and take. It’s a relationship on both sides and no-one wants to see a default,” said a source close to the talks.
Two other Australian energy companies also held talks with their lenders given the knock-on effect on balance sheets from the sharp decline in oil prices.
One fund manager with shares in Oil Search agreed banks were unlikely to play hardball given the stakes at play.
“I would find it astonishing if banks weren’t somewhat lenient with respect to covenant breaches across the globe and certainly in Australia. Because absent that, you may well find that the level of corporate bankruptcies is far greater than the banks themselves can stomach,” Allan Gray managing director Simon Mawhinney told The Weekend Australian.
For Wulff, the next cab off the rank was keeping the confidence of its big institutional investors.
Along with chairman Rick Lee, Wulff held back to back meetings with shareholders on We dnesday and Thursday as they sought assurances over its balance sheet.
Many backed the company’s relatively quick response to trim costs. However, several questioned whether it had gone far enough with Oil Search thought to be weighing further cuts for 2021 if required.
Others queried its ability to lower its break-even oil price and whether a review underway should now fundamentally change its operating model in Papua New Guinea.
One early casualty appears to be its $20bn LNG expansion in PNG. While Botten and Beth White, the company’s development head, continue to work on rekindling a deal the mood on the ground in Port Moresby is downbeat. “Officially it’s off and on hold,” PNG’s petroleum minister Kerenga Kua said. “The state side’s behaviour is affected by the differences between the parties but the investor side is impacted by the market. Everyone is going to take a hit from the oil price from the government in PNG to the joint venture companies to the landowners in the provinces. You can’t escape that.”
On Australia’s west coast, Woodside Petroleum is also under the pump. The nation’s largest energy company could cut its planned investment for this year in half according to analysts while the chances of moving ahead with its Scarborough LNG project and several pending equity selldowns will likely suffer delays or be ditched altogether.
Ian Macfarlane, a Woodside director and chief executive of the Queensland Resources Council, said it was difficult to gauge a floor for the oil price plunge.
“I think everyone in the industry was watching as the oil price fell below $US30 because that’s a pretty critical number for most companies,” Mr Macfarlane said. “LNG producers have contracts in place and are waiting to see where it all settles. It’s difficult to gauge how long this might last.”
Allan Gray, also a shareholder in Woodside, said the Perth producer had flexibility to ride through the price storm.
“They have gone into this downturn with a balance sheet far fitter than Oil Search and very little risk with respect to capital raisings or covenant breaches,” Mr Mawhinney said. “They basically have the same debt as Oil Search but own a business multiples the size. So it’s not an issue and there is no reason why they will push Scarborough or Browse at anything other than a pedestrian pace.”
Still, market experts say it takes a brave investor to wade into the market now given uncertainties in the market still to play out.
“Oil prices can still get much worse before getting better, so it’s hard for market participants to jump in just yet in pursuit of value plays,” Credit Suisse analyst Saul Kavonic said.
The coronavirus continues to shake global equities and the broader financial system but energy companies also have an added layer of volatility over the length of any crude downturn as Saudi Arabia’s state-run producer Aramco looks to retain its kingpin status by flooding the market with supply.
Negative prices for oil are even being floated as a possibility.
“The Saudis are pumping so much oil they are glutting the market. Analysts are saying it is possible we will see negative oil prices. Aramco will pay you to take oil,” tweeted investor Bianco Research this week.
Before that happens, Australian producers face tough decisions on cost cutting, pulling back dividends and even tapping the market for new equity. That raises both challenges for the cash strapped and opportunities for those spotting bargains in the market.
“If oil continues to drop, near term debt covenants could see pressure mount for large emergency equity raises to occur near market bottoms, with limited capacity from some existing shareholders to participate, risking dilution. Oil Search is most at risk of this of the larger Australian oil companies,” Mr Kavonic said.
Still, energy companies are used to riding the commodities rollercoaster and a rebound boom could eventually play out.
“If oil prices remain low, it could sow the seeds of the next oil boom, as deferment of new supply developments and stimulus measures potentially see a double whammy of lower supply and higher demand pressures from 2022,” Mr Kavonic said. “Companies able to withstand, and capture distressed opportunities during, the current crisis could end up big winners on a three year outlook.”