There are three questions tormenting investors in the oil and gas industry right now:
Why did Icahn double down on Occidental Petroleum? Is Warren Buffett right when he says “turnarounds seldom turn”? And how much longer can oil and gas companies hold out in this unrelenting storm?
And they all lead to the ultimate question: Should we be getting rid of our oil holdings?
Following the oil price war between Saudi Arabia and Russia, oil prices crashed by the most since the 1991 Gulf War and immediately sent hordes of energy companies on the path to bankruptcy.
Shale producers Occidental Petroleum Corp. (NYSE:OXY), Marathon Oil (NYSE:MRO) and Apache Corp. (NYSE:APA) fared worse than most, crashing spectacularly in a manner that is eerily reminiscent of the Lehman Bros. saga of 2008.
Smelling blood in the water, the sharks have started circling, waiting to pounce on their wounded victims.
And this could be just the beginning of the slaughter for the debt-ridden sector.
Signs Of The Times
In what is increasingly looking like the signs of the times, shale drillers Occidental Petroleum, Marathon Oil and Apache Corp. have faced the full wrath of shareholders for being the first to blink, with shares of the three companies losing roughly half their value on Monday.
On Monday, Occidental Petroleum announced that it was cutting its dividend and capital spending citing the sharp decline in crude prices. OXY announced a sharp 86% cut in the dividend from $0.79/share to just $0.11 and added that it plans to cut FY 2020 capex to from its previous range of $5.2B-$5.4B to $3.5B-$3.7B , a 32% reduction at the midpoint. The company also said it intends to implement further operating and corporate cost reductions:
"These actions lower our cash flow breakeven level to the low $30s WTI, excluding the benefit of our hedges, positioning us to succeed in a low commodity price environment," the company said.
But no amount of rationalization could placate enraged investors leading to OXY shares tanking 52% on Monday for the stock’s biggest one-day loss ever. OXY stock is now hovering around 19-year lows.
But that was just part of the carnage.
OXY’s most active bonds simply collapsed as the oil price war shook confidence in the oil and gas company. Occidental has been targeting $15 billion in proceeds from divestitures for use to pay down its heavy leverage following the controversial $38B acquisition of Anadarko last year. The company's 4.400% notes that are due for maturity in August 2049 cratered to 63 cents on the dollar from 90.14 cents in late trade Friday. The bonds had a yield spread of 665 basis points above comparable Treasurys.
And now, OXY has to contend with the fiery Carl Icahn, a long-time critic of the M&A deal. Icahn has just doubled down on a bid to take over control of Occidental Petroleum after upping his stake in the company from 2.5% at the end of last year to 10%.
Occidental's market value has now shrunk to less than a quarter of its $46B market cap just before the deal was struck.
It was more or less the same story at Marathon Oil, only a bit tamer.
The company announced an immediate capital spending reduction of at least $500M from its previous projection of $2.4B for 2020. The revised capex of $1.9B represents a sharp ~30% reduction from 2019 levels.
The cuts were done to "defend our cash-flow generation, protect our balance sheet, and fund our dividend”, President and CEO Lee Tillman said in a statement. Investors tend to be more forgiving when a company does not sacrifice the all-important dividend; however, that did not stop MRO stock from crashing 46%, a clear indication of just how much the mood has soared on the sector.
Worse Than 2016
Morgan Stanley has warned that the oil price wars and the coronavirus pandemic are about to expose more companies that binged on debt especially during the shale boom.
Seeking Alpha cited MS as saying that low oil prices ‘‘...will expose a "significant portion" of the $348B of investment grade index-eligible debt that is BBB rated to downgrade and aggravate strains in the broader U.S. credit market.’’
They expect energy defaults to surpass the 2016 peak.
Chesapeake Energy (NYSE:CHK) and Whiting Petroleum (NYSE:WLL) have been identified as being at the greatest level of default risk over the near-term (meaning in less than a year) while Antero Resources (NYSE:AR), Oasis Petroleum (NYSE:OAS) and Range Resources (NYSE:RRC) face the biggest risk in the intermediate term(meaning in 1-2 years).
Meanwhile, Stanley considers Occidental, Apache, Continental Resources, Cimarex Energy, Noble Energy, Marathon Oil and Hess as fallen angels risk rising.
Wall Street Divided
You would think that a case like OXY’s is cut-and-dried, but no, a cross-section of Wall Street seems to think otherwise. Related: Coronavirus Won’t Stop Luxury Buying
Four analysts’ takes on OXY, detailed by Seeking Alpha, show the wide disconnect in sentiment:
John Freeman, analyst at Raymond James, still thinks OXY is a buy thanks to “all-in” cash flow neutrality at $36/bbl WTI. In other words, from James’ perspective, OXY is solidly positioned to execute its capital and dividend payout programs without resorting to incremental borrowing.
In the same vein, Piper Sandler’s Ryan Todd recognizes that a lot of investors will be spooked by the massive oil price risks here, but that aside, he views OXY as a fairly sustainable company in the long term.
On the flip side, SunTrust's Neal Dingmann has remained on the sidelines with a Street-low $15 PT, calling the moves a "Hail Mary... likely to fall incomplete," meaning the company's cash flow outspend might still continue.
Morgan Stanley's Devin McDermott is equally unimpressed, saying "despite improved flexibility this provides, reducing elevated debt levels will be very challenging at strip prices."
Obviously, not everybody is about to give up on the energy sector despite many having thrown in the towel. But even for the brave (or foolhardy) investors looking for easy entry points, it’s advisable to remember that U.S. bear markets have in the past lasted 14 months in the period since World War II with market corrections lasting an average of five months.
Although a recovery is expected to start during the second half of the year, analysts expect the market to still finish in the red this year with a full recovery expected next year.
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