Last week, we delivered a message on behalf of Anadarko boss Al Walker.
Al’s message was simple: he and his friends are alcoholics and the only way they’re going to stop drinking is if you stop feeding them shots of cheap ass whiskey.
Here’s what Al said at a conference last month.
The biggest problem our industry faces today is you guys.
It’s kind of like going to AA. You know, we need a partner. We really need the investment community to show discipline.
That’s right. If you’d stop throwing money at US producers, then maybe they’d stop taking it from you. It’s kind of like how it’s your community’s fault if you won’t stop drinking yourself to death – if only they’d pass an ordinance to become a dry county, you’d be fine.
Of course the other problem is that executive compensation isn’t tied to profits. No, it’s tied to growth and the addition of new oil and gas reserves instead. If you add all of that up, you get this:
… if you connect the dots there, it means you are literally giving these management teams money to fund the growth that ends up boosting their compensation, and that growth is going to ultimately bankrupt the companies you’re investing in by creating a supply glut.
The whole thing is an exercise in futility. US operators are just charging up the down escalator and the faster they run, the faster the escalator runs in the opposite direction. It is, in short, a self-defeating dynamic. These companies are just working their asses off to bankrupt themselves.
So it follows that the only way this is going to come to an end is if the market starts punishing these companies with higher borrowing costs. For most of this year, credit has remained resilient in the face of multiple bouts of crude carnage and it was only last month when issuance finally dried up:
But given that there isn’t much of a near-term maturity wall, it’s not clear what part of that dearth of supply is due to higher yields and what part is due to companies simply not needing to borrow.
Well anyway, the bottom line is that the longer it takes credit markets to slam shut on these “alcoholics,” the longer the supply glut is going to last and the more debt these drunken fuckers are going to issue.
With that in mind, consider the following brief excerpt from a decent piece out Thursday from Goldman…
A word on Energy credit: what message to producers do sub-6% yields send?
For the first 3-5 months after oil prices fell from peak in 2014, energy high yield credit largely traded in line with equities. However, from late 2015 until oil prices bottomed in 1Q 2016, we saw Energy credit lag equities (as seen in Exhibit 5). This shifted around the November 30 OPEC meeting, and until last month we a saw sharp outperformance of credit relative to equities.
The arithmetic average yield of benchmark bonds for all covered E&Ps is 5% (excluding CRC, DNR, and EPE, 6% when including these three companies). We believe this may not send a requisite message to rein in drilling activity for all producers. On the flip side, it sends a theoretical message for producers to issue more debt.
It remains to be seen whether this will stimulate credit-financed M&A or increased outspending of cash flow to maintain rigs. Some investment grade companies may choose to rein in capital spending to maintain a healthy balance sheet and preserve a relatively low yield. But overall, to slow drilling activity from current levels, tougher signals to producers may need to be sent by credit markets.