By now we’ve all seen the headlines: “Oil crashes below $27 a barrel,” “Oil prices likely to remain low 3-5 years” and “U.S. oil bankruptcies spike 379%.” At first, these headlines seemed a little “distant” to me. It seemed unlikely that my clients would be affected dramatically and directly by the economic downturn in the oil industry, and, frankly, I didn’t mind paying less at the pump. The contemporary downturn in the natural gas industry certainly has hit home, though. The issue has community banks in our region taking notice and looking for solutions, while holding out optimism that the current downturn will not have long-lasting negative effects.
The Marcellus and Utica Shale boom has resulted in the greatest influx of “new wealth” that our region has seen in decades, if not ever. With the up-front bonus payments and royalties came the much need improvements to the farm buildings, new tractors, and the need for sophisticated estate planning as humble landowners turned into millionaires literally overnight. Additionally, with the drilling of new wells and construction of new pipelines, many new small businesses designed to provide services and supplies to the drillers and pipeliners began to spring up. In addition, new hotels began to dot the exits along Interstate 70 as entrepreneurs sought to meet the seemingly ceaseless demand for accommodations for the many out-of-state workers brought in to work on the wells and pipelines. It is the latter categories of commercial borrowers that sought financing for their operations from community banks.
Like crude oil, natural gas prices are in decline, having recently hit near 14-year lows. The average Henry Hub spot price (widely used as a national benchmark price for natural gas) of one thousand cubic feet of natural gas has fallen from $4.52 in 2014 to a current level around $2.72. As a result, the natural gas companies generally have less cash available to pay creditors – both lenders and trade creditors – and small businesses that provide services and products ancillary to the natural gas industry are feeling a pinch. In turn, this pinch is putting increased pressure on the business banking and special assets divisions of community banks.
What Can We Expect?
Well, it’s hard to say. According to the U.S. Energy Information Administration (“USEIA”), the future path of crude oil and natural gas prices can vary substantially, depending on assumptions about the size of global and domestic resources, demand for petroleum products and natural gas (particularly in non-Organization for Economic Cooperation and Development [“non-OECD”] countries), levels of production and supplies of other fuels. Future natural gas prices in particular will be influenced by a number of factors, including oil prices, resource availability and demand for natural gas.
With respect to natural gas prices in the short term, the USEIA reports that working natural gas underground storage for the week ending January 29, 2016 was 445 billion cubic feet (“bcf”) above the five-year average for this time of year and pressured natural gas prices back under $2 per million British thermal units (“MMBtu”). The front month futures contract for delivery at Henry Hub settled at $1.97/MMBtu on February 4, a decline of 36 cents/MMBtu compared to January 4.
Bankruptcies and Rumors of Bankruptcies
As alluded to in the opening sentence of this article, an unfortunate consequence of the drop in crude oil and natural gas prices is the sharp spike in bankruptcy filings by companies in the oil and natural gas industries. The chart below demonstrates the dramatic increase that 2015 saw in terms of bankruptcies in the oil and natural gas sector. In the short-term, I would expect more of the smaller, highly leveraged servicing and drilling companies to succumb to bankruptcy. In West Virginia, we have already seen the year’s first chapter 11 bankruptcy filing (Zone Construction and Excavation, LLC, Northern District of West Virginia Case No. 1:16-bk-00001) involving a company which, according to its Dun & Bradstreet profile, provides “well preparation and post-drilling services for oil and gas drillers in the Marcellus Shale region.” A quick examination of the debtor’s schedules and the docket sheet seems to tell a tale of what you might expect to see in one of these types of cases: assets consisting primarily of leveraged motor vehicles (mostly trucks) and heavy equipment particular to the debtor’s industry, along with the concomitant motions for relief from the automatic stay.
Is That Light at the End of the Tunnel, or an Oncoming Train?
Experts predict that record natural gas production and record natural gas inventory will put pressure on natural gas prices in the short term as well as the long term. In contrast, record low U.S. natural gas rig count and declining investments in oil and gas exploration and production could boost natural gas prices. Given such uncertainly, it’s hard to tell whether the light at the end of the tunnel is a way out or an oncoming train.
If you need help navigating the uncertain times ahead, please contact our Community Banking Practice Group