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Tuesday, September 23, 2008

Credit Crunch Hitting the Oil Patch

It appears no sector of the economy is immune from the credit crunch. The Wall Street Journal reported over the weekend that luxury goods and services are taking a hit (a slowdown in plastic surgery, quelle horreur!). Natural gas producers are also seeing the impact.

From Platts (hat tip reader Michael):

Chesapeake Energy CEO Aubrey McClendon said Tuesday he would not besurprised if US drillers dropped hundreds of rigs in the next couple of quarters due to lower natural gas prices.

“It wouldn’t surprise me if from 200 to 400 rigs were to come out of the rig count over the next six months,” McClendon …. “I expect [the dropping of rigs] to be forthcoming.”

Chesapeake on Monday said this week it would cut capital spending by $3.2 billion in the next 10 quarters and trim its drilling rig count because of falling natural gas prices.

McClendon said gas prices that hovered in the $13s/Mcf range in the first half of 2008 yielded good returns on drilling and production, and “in that world you can run up to 2,000 rigs profitably.”

However, “in the world of the last 60 days of $7/Mcf and change to $8/Mcf and change, I just don’t think the cash is there to support that kind of drilling activity, and the credit crunch won’t be favorable to companies that have to borrow a bunch of money to support drilling activity,” he said…

McClendon added he expects to see service costs go down in tandem with less rigs working. “If we lose a couple of hundred rigs in the next couple of months, that will help,” he said.

Topics: Commodities, Credit markets

Email This Post Email This Post Posted by Yves Smith at 3:09 pm

17 Comments » Links to this post

17 Comments:

  • Matthew Dubuque says:
    September 23, 2008 at 3:26 pm

    Matthew Dubuque

    The loss of 200 rigs in the USA is indeed significant.

    Indeed, there is NO segment immune from the credit crash.

    If that is unclear now, it will be abundantly clear to all before March of next year at the latest.

    Matthew Dubuque
    mdubuque@yahoo.com

  • doc holiday says:
    September 23, 2008 at 3:47 pm

    That made my day, thank you!!

    Re: The financial markets were simply more out of whack than her 16-year-old’s proboscis.

    “The other noses were more prominent,” the stay-at-home mother from a tony New York City suburb in Westchester County told her 16-year-old daughter. She could get hers done when things settled down.

  • Robert Boyd says:
    September 23, 2008 at 4:00 pm

    I’m not sure what this has to do with the credit crunch per se. In a general sense, you can speculate that the price of natural gas is dropping due to a slow-down in the economy which is due to the mortgage meltdown. Maybe. But gas is a pretty volatile commodity that has a lot of other things affecting it, including increasing supply. Companies are drilling like crazy in all these shale plays, so more supply is coming on the market with predictable results. And the resulting lower prices will stop more marginal production, at least temporarily.

    The credit crunch affects everything, but it’s not the only thing affecting U.S. industries. Never forget that each industry still has its own idiosyncracies that might produce its own volatility.

  • Marco says:
    September 23, 2008 at 4:10 pm

    do not drill baby, do not drill !!!

  • Anonymous says:
    September 23, 2008 at 4:12 pm

    Unintended consequence? Should be lots of those with the government trying to control things.

    People will cutback to the bare bone but their reward will be inflation-the hidden tax.

  • mxq says:
    September 23, 2008 at 4:33 pm

    “I’m not sure what this has to do with the credit crunch per se.”

    This has a lot to do with the credit crunch. First of all, the low nat gas prices are merely coincidental.

    Second, if you look at the balance sheet of a company like Chesapeake, you will see they have to lever up quite a bit and run very low cash balances (its a capital intensive business when you actually drill for gas/oil – unlike the XOM’s of the world, which are just giant buyback machines).

    In addition, CHK already has a ton of capital tied up in their hedging activities (and correct me if I’m wrong, they don’t even have to use cash for margin, they can actual put up production for margin), so their credit lines with credit providers isn’t going to grow ad infinitum.

    The point being, with nat gas prices more or less where they were in 06-07, the only thing that has really changed is credit availability — yet they are pairing their drilling activity. I’m not saying 100% of the decision is based upon credit, but it was definitely a factor (as McClendon said).

    n/p

  • mxq says:
    September 23, 2008 at 4:41 pm

    And just to clarify when I say “the only thing that has really changed is credit availability”…i’m assuming credit availability and nat gas prices are the only variables we take into account. (in actuality, supply/Demand are probably the biggest issues when making the decision to increase or decrease production.)

  • Lewis B. Sckolnick says:
    September 23, 2008 at 5:30 pm

    How fast the Summer of ‘08 became the ‘Good Old Days’. Don’t wait for that market to return go to the new market.

  • jkiss says:
    September 23, 2008 at 6:59 pm

    I’m 63. My lifetime is precisely the period that people will look back on and call ‘the good old days’.

    IMO we cannot borrow what we need – so far the fiscal deficit will go up 4x – at low interest rates. If this is true and interest rates climb, the dollar will be strong. Further, high interest rates mean that many leveraged companies will go bk, and high rates plus rising unemployment will push previously sound companies over the edge, too. This means recession and deflation. High interest rates/falling gdp will be terrible for equities/precious metals/exports but good for the dollar.
    High rates, high unemployment… does anybody remember the ‘misery index’?
    Oh, and peak oil…

  • Anonymous says:
    September 23, 2008 at 7:50 pm

    Aubrey isn’t talking about the credit crunch. He’s talking about gas at less than $8/MBTU. When gas goes below a range of $8-10 CHK produces less.

  • mxq says:
    September 23, 2008 at 8:59 pm

    “Aubrey isn’t talking about the credit crunch…When gas goes below a range of $8-10 CHK produces less.”

    Not to belabor this point, but CHK and its ilk are definitely feeling the effects of the crunch – gas prices nonwithstanding.

    Aside from the fact that the CEO said word for word, the credit crunch isn’t helping, they just did an equity offering in July for $1.6bn, yet gas prices were in the $13-$14 range. They did another billion in march. Gas prices were ~$10 then. Given high gas prices, if credit were so easy, why dilute sharholders by 20%?

    I don't want to focus on individual companies, because we're missing the forest for the trees, but the majority of CHK's and other independent E&P's existence as going concerns have been when nat gas was below $8.

    I'm not sure if everyone's collective frame has shifted in the past few years because of higher hydrocarbon prices (i wouldn't be suprised if this was the case), but $8 gas isn't exactly killing these guys…but the banks are definitely not helping.

  • macndub says:
    September 23, 2008 at 9:05 pm

    Nobody in any business talks his book more than McClendon, and I’m including Gross of Pimco.

    Chesapeake has locked in gas sales contracts at attractive prices for the vast majority of its production next year, so it certainly won’t be cutting back on drilling. But the company is facing a future of exploding shale gas development: upwards of 25% of current Lower 48 gas supply in some cases.

    In just two years gas analysts have gone from hand wringing about a supply collapse to hand wringing about an enormous oversupply. Peak Oil has nothing on the potential gas bubble coming up: projects to export gas to Europe from North America are now finding traction.

    McClendon is partly responsible for this enormous supply bubble. So now he says, “Don’t worry about all that gas. It will never show up, because prices will collapse and rigs will stop drilling. Won’t affect me, because I’ve locked in at $12/MMBTU. Have another beer! Buy my stock!”

  • macndub says:
    September 23, 2008 at 9:07 pm

    MXQ, he’s not diluting his shareholders. Aubrey is GROWING HIS COMPANY. Every shareholder is getting a bigger piece of future gas production because he’s actually–shocker–deploying capital in positive NPV projects.

    Astounding, I know, but this is how money used to be made in USAia.

  • macndub says:
    September 23, 2008 at 9:16 pm

    Ack! Sorry, correction: Chesapeake has locked in gas sales contracts at attractive prices for the vast majority of its production next year, so it certainly won’t be cutting back on drilling.

    The word “certainly” should have been “immediately”.

  • mxq says:
    September 23, 2008 at 9:30 pm

    macndub…see, this is why i hate about talking individual companies. The whole point of the thread was to show the credit crunch is hitting anything with leverage, including companies that are seemingly unrelated to housing, cdos, etc. I’m not gonna debate the economic return on the share issuance. Prima facie, share issuance is a way to finance while not having to rely on banks.

  • macndub says:
    September 24, 2008 at 11:55 am

    mxq, fair enough. Apologies for overreacting. There is a credit crunch in the gas business, but a 50% drop in the price of gas completely overwhelms anything going on in the credit markets.

    In a world where cash flow is king, companies that generate a lot of cash flow (oil and gas among them) are not really in that bad shape. If oil and gas prices do collapse, though, all bets are off.

  • mxq says:
    September 24, 2008 at 4:47 pm

    no problem…Platt’s had another piece today, quoting SW Energy’s CEO about relative nat gas prices:

    “Harold Korell, the CEO of the Fayetteville’s leading operator, Houston-based Southwestern Energy, chuckled when questioned about the impact of low natural gas prices. “Seven dollars is low?” he said. “Not in our time.”

    The article actually talks a bit more about how the credit crunch may cause companies to operate with “more discipline,” but actually might keep smaller, newer players out of the market.

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