During a recent lunch discussion, a fellow energy industry observer pondered how long U.S. producers would keep pumping $70 oil and selling it for $40 on the world market. His prices were a bit extreme, but I got his point. Drilling in U.S. shale formations is expensive, and projects that were lucrative a year ago when oil was selling for $100 a barrel no longer are.
“As long as people are going to give them cheap money,” was my reply. Unlike previous oil busts, this latest downturn in global prices has been marked by a persistent willingness for investors to keep pumping money into the industry, betting that prices will rebound.
That didn’t happen in the 1980s. Back then, bankers were the primary source of capital for many drillers who couldn’t tap the equity markets. When banks saw prices plunging by more than 60 percent, they turned off the spigots and cash dried up.
In the current downturn, producers have responded as they typically do, shutting in shale production as oil prices have fallen. What’s surprising, though, is that we haven’t seen more projects put on hold. U.S. oil stockpiles rose to almost 491 million barrels in the week ended April 24, their highest level since 1930, according to the U.S. Energy Information Administration.
Sure, lower prices have begun to hit the bottom line of companies like EOG Resources, the biggest shale producer, which lost money in the first quarter, but the slightest easing of the supply glut this week sent oil prices shooting back above $60 a barrel.
That kind of price rebound, while a far cry from the $100 a barrel we saw last year at this time, is enough of a surge to maintain optimism in financing circles. A survey of energy industry participants conducted by Douglas Westwood for Energy Voice found that an overwhelming number believed oil prices will remain above $60, and more than half said they are confident prices will be at or above $100 in five years.
The capital markets seem to agree. In the first quarter, for example, companies issued about $10 billion in junk bonds and another $10 billion in new stock issues, private equity investor Carl Tricoli, with Denham Capital, told Forbes recently.
Today, oil companies find themselves with a greater array of financing options. Junk bonds no longer carry the stigma they did in the 80s, when Michael Milken’s escapades made them toxic.
Even more important, private equity continues to be enamored with energy. Blackstone Group launched a $4.5 billion energy fund in February, looking for distressed assets, a Warburg Pincus started a similar $4 billion investment program last fall. In fact, in the past two years, private equity has raised a staggering $101 billion for energy investments, according to Preqin, which tracks data on alternative investments.
Unlike banks, private equity firms tend to project returns on a five-year horizon, meaning the funds being deployed now are basically a bet on oil prices rebounding by 2020. It’s little wonder that most companies surveyed by Energy Voice found that increased investment would be one of the main drivers of the oil price recovery.
Adding to the attractiveness for long-term investors, many companies are using the price downturn to reduce costs and develop greater operating efficiencies. To the extent that such programs continue once prices rebound, companies may be generating fatter margins than they were during the boom.
Of course, a prolonged downturn of several years could begin to erode the optimism. Indeed, as my lunch companion pointed out, companies won’t continue to produce oil for $70 and sell it at $40. But for now, at least, they aren’t having any trouble finding sources of capital to underwrite their operations.
The availability of easy money stands in stark contrasts to previous busts. Not only does it make it easier for companies to weather the downturn, it also makes it easier for them to keep drilling when it might otherwise not make economic sense.
By Loren Steffy