⛽️Even the Permian Isn’t Infallible (Long Heaps of Oil & Gas Distress)⛽️

 

Even at 95 years old, you can’t get one past Charlie Munger. #Legend.

The Permian Basin in West Texas is where it’s at in the world of oil and gas exploration and production. Per Wikipedia:

As of 2018, the Permian Basin has produced more than 33 billion barrels of oil, along with 118 trillion cubic feet of natural gas. This production accounts for 20% of US crude oil production and 7% of US dry natural gas production. While the production was thought to have peaked in the early 1970s, new technologies for oil extraction, such as hydraulic fracturing and horizontal drilling have increased production dramatically. Estimates from the Energy Information Administration have predicted that proven reserves in the Permian Basin still hold 5 billion barrels of oil and approximately 19 trillion cubic feet of natural gas.

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And it may be even more prolific than originally thought. Norwegian research firm Rystad Energy recently issued a report indicating that Permian projected output was already above 4.5mm barrels a day in May with volumes exceeding 5mm barrels in June. This staggering level of production is pushing total U.S. oil production to approximately 12.5mm barrels per day in May. That means the Permian now accounts for 36% of US crude oil production — a significant increase over 2018. Normalized across 365 days, that would be a 1.64 billion barrel run rate. This is despite (a) rigs coming offline in the Permian and (b) natural gas flaring and venting reaching all-time highs in Q1 ‘19 due to a lack of pipelines. Come again? That’s right. The Permian is producing in quantities larger than pipelines can accommodate. Per Reuters:

Producers burned or vented 661 million cubic feet per day (mmcfd) in the Permian Basin of West Texas and eastern New Mexico, the field that has driven the U.S. to record oil production, according to a new report from Rystad Energy.

The Permian’s first-quarter flaring and venting level more than doubles the production of the U.S. Gulf of Mexico’s most productive gas facility, Royal Dutch Shell’s Mars-Ursa complex, which produces about 260 to 270 mmcfd of gas.

The Permian isn’t alone in this, however. The Bakken shale field in North Dakota is also flaring at a high level. More from Reuters:

Together, the two oil fields on a yearly basis are burning and venting more than the gas demand in countries that include Hungary, Israel, Azerbaijan, Colombia and Romania, according to the report.

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All of which brings us to Legacy Reserves Inc. ($LGCY). Despite the midstream challenges, one could be forgiven for thinking that any operators engaged in E&P in the Permian might be insulated from commodity price declines and other macro headwinds. That position, however, would be wrong.

Legacy is a publicly-traded energy company engaged in the acquisition, development, production of oil and nat gas properties; its primary operations are in the Permian Basin (its largest operating region, historically), East Texas, and in the Rocky Mountain and Mid-Continent regions. While some of these basins may produce gobs of oil and gas, acquisition and production is nevertheless a HIGHLY capital intensive endeavor. And, here, like with many other E&P companies that have recently made their way into the bankruptcy bin, “significant capital” translates to “significant debt.”

Per the Company:

Like similar companies in this industry, the Company’s oil and natural gas operations, including their exploration, drilling, and production operations, are capital-intensive activities that require access to significant amounts of capital.  An oil price environment that has not recovered from the downturn seen in mid-2014 and the Company’s limited access to new capital have adversely affected the Company’s business. The Company further had liquidity constraints through borrowing base redeterminations under the Prepetition RBL Credit Agreement, as well as an inability to refinance or extend the maturity of the Prepetition RBL Credit Agreement beyond May 31, 2019.

This is the company’s capital structure:

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The company made two acquisitions in mid-2015 costing over $540mm. These acquisitions proved to be ill-timed given the longer-than-expected downturn in oil and gas. Per the Company:

In hindsight, despite the GP Board’s and management’s favorable view of the potential future opportunities afforded by these acquisitions and the high-caliber employees hired by the Company in connection therewith, these two acquisitions consumed disproportionately large amounts of the Company’s liquidity during a difficult industry period.

WHOOPS. It’s a good thing there were no public investors in this thing who were in it for the high yield and favorable tax treatment.*

Yet, the company was able to avoid a prior bankruptcy when various other E&P companies were falling like flies. Why was that? Insert the “drillco” structure here: the company entered into a development agreement with private equity firm TPG Special Situations Partners to drill, baby, drill (as opposed to acquire). What’s a drillco structure? Quite simply, the PE firm provided capital in return for a wellbore interest in the wells that it capitalized. Once TPG clears a specified IRR in relation to any specific well, any remaining proceeds revert to the operator. This structure — along with efforts to delever through out of court exchanges of debt — provided the company with much-needed runway during a rough macro patch.

It didn’t last, however. Liquidity continued to be a pervasive problem and it became abundantly clear that the company required a holistic solution to its balance sheet. That’s what this filing will achieve: this chapter 11 case is a financial restructuring backed by a Restructuring Support Agreement agreed to by nearly the entirety of the capital structure — down through the unsecured notes. Per the Company:

The Global RSA contemplates $256.3 million in backstopped equity commitments, $500.0 million in committed exit financing from the existing RBL Lenders, the equitization of approximately $815.8 million of prepetition debt, and payment in full of the Debtors’ general unsecured creditors.

Said another way, the Permian holds far too much promise for parties in interest to walk away from it without maintaining optionality for the future.

*Investors got burned multiple times along the way here. How did management do? Here is one view (view thread: it’s precious):

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What Comes Next? (Healthcare? More Oil & Gas? More Retail?)

Oil and gas exploration and production is SO 2016. Everyone is sick of 2017's #retailapocalypse. So, now what? 

The above notwithstanding, there are many who believe that oil restructurings will hit again if (when?) oil dips below $40/barrel again. Early reorganizations that didn't delever enough or didn't tackle bloated SG&A will need a solution - even if just to stay competitive with companies that did, in fact, file and clean themselves up (though, based on the recent trading levels of post-reorg equities, some of those guys aren't doing so hot either; notably, none of them have gotten the support of a large institutional sponsor behind them). And some Chapter 22s may start rolling in too. 

On the retail side, November is not too far away. If retailers can't bridge themselves to Q4/Q1 by this point, they're probably beyond repair. 

In the meantime, restructuring professionals are earnestly turning their attention to "healthcare" - a catch-all category that subsumes various subsegments like biotech, pharma, and medical services. Industry decks have been circulating around like wildfire to the point where we have a pool as to whether we'll read more banker/advisor decks in the next 12 months than we'll see meaningful bankruptcies in that time (who wants in?). Leading indicator of hype-flow: the panels are starting. Last Monday there was a New York City Bar panel on healthcare issues.

So far in 2017, there have been a number of healthcare-related bankruptcies spanning across the various subsegments including, among others, 21st Century OncologyAdeptus Health Inc.Halt Medical Inc.Bostwick Laboratories Inc.Unilife Corporation, and California Proton Treatment Center. There have been a number of smaller deals too but those don't ramp up advisory fees, e.g., this one from this week. Healthcare services providers have also been hurt, e.g., Angelica Corporation. And there are tons of other sizable healthcare names on distressed watchlists - though it's unclear whether they'll ultimately file for bankruptcy, e.g., Pernix Therapeutics ($PTX), HCR Manorcare (Carlyle Group owned), and Concordia International Corp. ($CXRX).

Getting out ahead of all of this, some Kramer Levin Naftalis & Frankel LLP attorneys released a recent thought-piece issuing a "Code Red" for the healthcare industry. They delineate the various reasons why healthcare is the new hot thing - from uncertainty around the ACA/AHCA (even with this week's release of Trumpcare Senate-version) to reimbursement pressure from Medicare to the change to bundled payments (rather than "fee for service" payments) to unsustainable capital structures emanating out of debt-driven acquisitions. A "Code Red" ladies and gentlemen. Hold on to your butts. 

Now, there are unique considerations that apply to healthcare restructurings - one among them the likelihood of the appointment of a Patient Care Ombudsman - which just means that there'll be another contingent of estate-sponsored advisors soaking up fees. That prospect alone probably gets juices flowing. Professionals love tables with a lot of seats around them. 

But, most of the companies highlighted in decks don't have maturities until 2019 or 2020 and so this has to, in the near-term, be a liquidity/covenant story...? Maybe. And it's unclear how that story will unfold - particularly with so much regulatory overhang. We're wondering if all of the current focus on healthcare is more hype than substance and maybe is a bit premature...? What do you think?

On an aside, we read stuff like this and it makes us less inclined to make jokes and more inclined to beat someone's a$$. This is people's health we're talking about and so it's disconcerting to see physicians speaking openly and publicly about deficiencies that are sparked by the need to service debt.  

Want to tell us we're morons? Or praise us? Cool, either way: email us

What About the Children?

This was a big (bankruptcy) week for oil field servicers. 

After months of upstream idling and cost cutting, expert predictions of a cascade through the midstream space finally came true with a trio of prepackaged bankruptcy cases: Key Energy Services Inc.Basic Energy Services and American Gilsonite. With oil mired in the $50/barrel range, upstream producers cut capex, competitive servicers cut pricing, and suddenly - in the example of Key Energy - $1b in funded debt became entirely unsustainable. Shocker.   

And yet Key's bankruptcy papers paint a picture of...success?!? Sure, we'll give some credit: a consensual prepackaged case with a two-month timeline is a shining star in an industry rife with supposed prearranged deals that descend quicker into chaos than Donald Trump at a presidential debate (we're looking at you Samson Resources, Sabine, and Midstates Petroleum). But let's not lose perspective here... 

Platinum Equity will come out as the largest equity holder. Various creditors will swap their debt for equity. Chevron will continue to receive services. Shareholders? C'mon. Key was a publicly-traded company. No one cares. 

J. Marshall Dodsen, CFO of Key, noted that Key undertook dramatic measures to stave off bankruptcy including shutting down business lines, selling assets, and riffing employees like nobody's business. He laid off 55% of the workforce. Some quick math here: 2900 employees remain...55% gone...carry the one...yup, 1600 employees axed. What a hero. 

Notably, Basic Energy's papers highlight a 30% headcount reduction as compared to 2014 (read: before oil cratered). While American Gilsonite noted that firings were part of its pre-filing cost-cutting strategy, it spared us from the exactitude. Outside of the bankruptcy court, we learned this week - in the context of reporting a $429mm net loss - that Baker Hughes has eliminated nearly 25,000 jobs during this commodity-price downturn. 

Sadly, nobody is earnestly talking about the real world implications of this debt-laden SG&A-ridden cowboy culture collapsing before our very eyes. But they should be. Because clearly people are losing jobs. Lots of people. 

It doesn't stop there. We singled out Samson and Midstates for a reason. And that's because Oklahoma is a complete and utter hot mess right now. Aside from lining biglaw and advisory pockets, these cases (and, of course, the oil price decline generally) have had other very real consequences. We recommend that you watch the 10/21/16 episode of Vice News on HBO for more detail but, suffice it to say, the oil bust is hitting the children. Lost oil revenue has destroyed school budgets and this means fewer school days for Oklahoma kids. To make up for this, the state is proposing a sales tax increase that would propel Oklahoma to the top of the combined state/local tax rates. If there is no other explanation for this crazy election season, there is this: people do desperate things when children are involved.

The restructuring industry is abuzz about this week's uptick in filings after a relatively slow Q3. But there are bigger forces at play here. Let's hope those Oklahoma children are safe when the next big force of an earthquake strikes.