Distressed energy companies: drilling down

Private equity firms love a bargain, so the downtrodden energy sector is their latest hunting ground. But before they start shopping, they will have to reckon with past deals gone bad.

Samson Resources is perhaps the most notorious example of a soured deal. KKR, leading a group of investors, acquired the oil and gas producer for $7bn in 2011. It was then considered a relatively safe deal - KKR and friends put up more than half the purchase price in equity. But in 2014 Samson's cash flow deficit swelled to nearly $400m as it could not keep up with financing and capital costs.

Earlier this week, Samson admitted it could file for bankruptcy. As its high-yield bonds are wallowing around 20 cents, this is no shocker. In the meantime, Samson is taking the usual steps to find breathing room - capital spending will be cut by three-quarters, employees fired, loan covenants amended and assets put on the auction block.

Yet falling oil and gas prices have not led to a surge of defaults in the energy sector. According to Fitch Ratings, the trailing annual default rate at US oil and gas producers is only 1.9 per cent, just at the historical average. (That is despite recent bankruptcy filings at Dune Energy and Quicksilver Resources, and a missed interest payment at American Eagle Energy.)

Relatively strong debt and equity markets (aided by private equity and hedge funds) have allowed many energy companies to access the financing needed to fight another day.

But the problem with such gambits is that they are only stopgaps to enable the companies to meet existing financial obligations. The production boom in the US has been driven by the nearly $250bn of high-yield bonds that are currently outstanding. If producers are unable to invest in drilling wells then they will have no output to sell. That falling production should, eventually, boost oil and gas prices. But fewer companies will still be around to enjoy that rally.

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