A recent EIA analysis focusing on on-shore drilling companies revealed that 40 U.S. companies have lost a combined $67 billion dollars. Eighteen of these companies make up $57 billion of the losses, all of which had an average debt to equity ratio of 99% according to the EIA.
The majority of these losses are due to the exuberant debt that these companies incurred during more profitable times. When the oil price was soaring high around $100, many companies thought it prudent to leverage their positions and expand quickly. However, when the oil market took a turn for the worst, these companies were stuck with large amounts debt that they couldn’t pay off.
It is natural for ambitious companies to take on debt to advance potential growth, but they need to ensure profitability in order to manage this debt effectively. Before the oil price crashed because of OPEC’s oversupplying of the world market, these companies were wise to take on certain amounts of debt in order to accelerate growth. However, the unexpected and rapid decline in the oil price forced them into a tough position.
A process known as redetermination is when banks examine a companies ability to make good on its loans and other debt. The EIA expressed concern over the possibility of banks pulling certain oil and gas companies’ short-term credit. Chesapeake Energy recently convinced its creditors to keep a $4 billion credit line open by offering most of the company’s assets as collateral.
The credit given to certain companies affects their ability to operate on a daily basis. If such credit would be retracted the results would bring about catastrophic results. Fortunately, the banks have not been too strict on these companies’ credit lines, perhaps because they believe that a recovery is just around the corner.
Article written by HEI contributor Timothy McNally.