Weekly Puzzle #9: Debt and Distress

The Oil Price Collapse and the Debt Problem

One of the big stories of the last year has been the precipitous drop in oil prices, with no bottom in sight yet. That oil price drop is bad news for all oil companies, no matter where they fall in the production spectrum, and will translate into lower profitability in the future. The problem, though, is that many of these oil companies have been conditioned over the last decade to act like $100+ oil prices were here to stay and have not only invested on that basis, but borrowed as well. This article provides the big picture perspective on how levered the sector is and how lower oil prices are impacting it.

The debris is starting to pile up as oil prices stay down and debt payments start to come due. This article is one of many that points to this phenomenon and you have probably been reading about oil companies either entering Chapter 11 or thinking about doing so. This list will get longer and to help you find the next victims, here is the list of all oil companies listed globally with total debt outstanding and the numbers that you can scale the debt to to get measure of how indebted they are(Debt ratio(market), Debt ratio (book), Debt/EBITDA, Interest coverage ratio) and bond ratings, if available.

Key Questions to Answer

1. When these companies borrowed money, they clearly felt that the benefits of debt outweighed the costs. Put yourself back in 2009 or 2010 and make the judgments on the elements of the trade off then (without the benefit of hindsight) and give your unbiased judgment on how much debt you would have advise an oil company to carry?
2. Make a list of oil companies that you see as most at risk from their debt burdens.
3. Now these companies have much lower income and are facing potential default (nearer for some than others). Assuming that you are the CEO of a highly levered oil company, what are the potential indirect bankruptcy costs that you may face? (Lost sales? Higher costs? )
4. At this point, what the lenders in levered oil firms want them to do and what equity investors in these firms would like them to do will be very different? Can you think of what these differences will be in investment, financing and dividend policy terms?