Energy companies think they’ve finally got their debt loads under control and can use more cash to buy back shares. That worries at least some bond investors.
So far this year, companies in the S&P 500 Energy index have pledged to repurchase more than $20bn of shares, the most since before oil plunged in 2015. Companies including oil drillers Noble Energy, Anadarko Petroleum Corp and Devon Energy Corp have announced new buyback programmes or dialled up existing ones since the beginning of the year.
Debt levels for energy companies have been falling since 2016, but are still high by historical standards. If S&P 500 energy companies were putting their excess money toward paying down borrowings instead of buying back shares, they could be shrinking their obligations by almost 30%.
Buying back shares will just send money out the door without investing in companies’ future revenue or cutting future obligations, said Gary Stromberg, who runs high-yield energy research at PGIM Fixed Income, which manages $716bn. The companies could end up struggling again if energy prices fall, which is a real possibility as emerging markets show further signs of weakness or if long-term demand goes down, he said.
“It’s a downward spiral,” Stromberg said. “Companies would really have to think about buying back stock and having to focus on liquidity.”
Energy companies have been through this before - in fact, just a few years ago. Crude oil prices plunged more than 75% between 2014 and February 2016, spurring banks to slash their credit lines. By the end of 2016 more than 100 drillers with debt topping $70bn had filed for bankruptcy, according to a report from law firm Haynes and Boone, including Linn Energy Inc and SandRidge Energy.
When oil prices started climbing again in 2016, companies started taming their debt loads. Devon, for example, cut its total borrowings to less than $10bn in the first quarter from more than $13bn at the end of 2015, in part by selling assets.
The ratio of debt to total assets among S&P 500 energy companies was 21.9 times in the three months through June, down from 25.2 times two years earlier. Current levels are low enough to help junk-rated energy bonds rise 1.9% this year through Wednesday, outpacing total high-yield debt’s 1.4% jump.
But debt ratios are still high by the standards of the last two decades. The average ratio of debt to total assets between 2000 and 2008, annually, was 17.66, according to data compiled by Bloomberg. The ratio of debt to earnings before interest, taxes, depreciation and amortisation shows a similar pattern: it’s fallen in the last few years, but is still high compared with earlier periods. Meanwhile, stock investors are getting restless. Energy stocks are performing worse than the broader market, with the S&P 500 Energy Index having gained 1.1% this year through Wednesday, including dividends, about 5.5 percentage points worse than the S&P. Oil companies are feeling pressure from shareholders to improve that performance, according to Bloomberg Intelligence analyst Spencer Cutter.
“I think we’ll see more share buybacks announced in the next couple quarters,” Cutter said. In the last year or two, companies with free cash “would pay down debt. Now most of it is going to shareholders.”
Many oil companies aren’t getting the full benefit of higher prices now. PetroNerds, an energy analytics firm, said that companies have hedged future sales at under $60 a barrel, meaning they’re missing out on some of the gains that come from US crude being around $67 a barrel now. These underwater hedges have cost shale drillers $1.5bn in the three months through June, PetroNerds said.
There are signs that the rally in energy might not hold. Crude oil futures for coming months are below current prices, signalling that prices may fall. Climbing production in the US or Opec, a stronger US dollar, or global geopolitical issues could contribute a decline, said Cutter.
“Any contagion from the Turkey issue, which results in a stronger US dollar, could be bad for oil prices,” Cutter said. “Theoretically, that contagion could also slow economic growth in certain parts of the world, lowering demand for oil.”
Manual shutdown equipment is seen at an Anadarko Petroleum oil rig in Fort Lupton, Colorado (file). Companies including Anadarko Petroleum, Noble Energy, and Devon Energy have announced new buyback programmes or dialled up existing ones since the beginning of the year.
