Fracking Companies Pay Off Large Debts With Abundant Funds

The U.S. shale industry is finally starting to see some positive financial results. After years of operating at a loss, many companies are now starting to see profits. This is thanks to a combination of factors, including cost-cutting measures and higher oil and gas prices.

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After carrying enormous debt loads for more than a decade, frackers have paid down billions of dollars in debt since the start of the coronavirus pandemic. They have capitalized on higher commodity prices and stuck to austerity pledges.

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According to FactSet, the 10 largest independent oil and gas producers by market capitalization have collectively reduced their debt by approximately 17% between the third quarters of 2019 and 2022, down to $84 billion. Occidental Petroleum Corp. has reduced its debt by more than half to $21.8 billion. Marathon Oil Corp.'s debt has shrunk by some 26% to $4.24 billion. EOG Resources Inc.'s debt has dropped by about 12% to $5.31 billion.

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The energy sector has been able to reduce its debt more effectively than other industries in the face of rising interest rates and inflation. From 2019 to the end of the third quarter of 2022, the energy sector cut its total debt by a median value of 8.7%. In contrast, industries such as communication services and real estate increased their debt by 31.6% and 18.5%, respectively. This data comes from S&P Global Market Intelligence.

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Shoring up balance sheets is one of the commitments that shale companies have made to lure back investors. Other commitments include reining in production and returning cash to shareholders via share buybacks and dividends. The focus on deleveraging positions companies well to stomach rising interest rates and gyrations in oil prices, analysts and executives said.

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James Walter, co-chief executive of Permian Resources Corp., a Texas oil producer, said that if commodity prices stay low for a while, the sector will be able to cope much better.

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Cheap financing played a role in funding the shale boom and helped propel U.S. oil production to a peak of 13 million barrels a day before the pandemic. This soaring growth was backed by the hundreds of billions of dollars in borrowed cash that drillers spent to develop oil fields from Texas to North Dakota.
The race to exploit shale rock has had a negative impact on the industry's financial health. According to a report by Deloitte Touche Tohmatsu LLC, North American shale producers have lost some $300 billion over the past decade by focusing on growth. Oil price crashes in 2014-2016 and during the pandemic have caused hundreds of companies to go bankrupt.

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As frackers' financial performance worsened, lenders began to lose faith. Banks and investors have since pressured producers to use their remaining funds to pay off debt and return capital to shareholders, rather than investing in new production.
"It took a long time for the investment community to get the E&Ps to focus on returns rather than growth," said Robert Drummond, CEO of oilfield services company NexTier Oilfield Solutions Inc.

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Banks have significantly reduced their lending to the shale sector, and high-yield markets have largely closed their doors to shale companies, limiting producers’ ability to get new loans, said Jeff Nichols, co-chair of the energy practice at law firm Haynes & Boone LLP. The change in sentiment has left shale companies with few options but to slash spending and pump oil on their own dime. While crude prices have remained elevated for more than a year, most large oil producers have set production growth targets that don’t exceed 5% for 2023.

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After the pandemic forced many companies to streamline their operations, drillers were able to take advantage of the resulting increase in efficiency when global oil prices rose more than 50% to $80 a barrel in 2021. Crude-supply disruptions following Russia’s invasion of Ukraine sent Brent prices even higher, to about $123 a barrel, further filling companies’ coffers and allowing many of them to repay their debt and reach investment grade.

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Last year, oil-focused shale companies generated a combined $62.4 billion in free cash flow through the third quarter, making it their best year yet, according to energy consulting firm Wood Mackenzie. This outperforms other sectors, with the S&P 500's energy index up 44% in the past year.
Jason Pigott, chief executive of Vital Energy Inc., said that the company focused on using its free cash flow to pay down debt, rather than increasing its level of activity. Previously, the company was known as Laredo Petroleum Inc.

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The company, which produces mostly crude oil, reported revenue of about $1 billion for the nine months ended September. This is about double the revenue from the same period in 2021. Its long-term debt hit $1.44 billion at the end of 2021, but has since decreased by about $249 million. Vital still plans to grow, but will only issue new debt if it finds suitable assets to purchase and add to its inventory, said Chief Financial Officer Bryan Lemmerman.

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Charles Johnston, a senior analyst at credit research firm CreditSights, said that because shale companies have focused on debt reduction as the priority for the substantial cash flow generated in 2022, most don’t need to issue new debt to refinance and have limited exposure to rising interest rates. The U.S. high-yield energy bond index has shrunk by about 25% since 2021 to $157 billion, largely thanks to issuers’ improving balance sheets, according to CreditSights.

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Companies that refinance their debt will face higher interest expenses, but analysts at Moody's Investors Service expect that increased fixed interest rates will be offset in part by companies' shrinking total debt outstanding.

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The Federal Reserve approved an interest-rate increase of 0.5 percentage point in December, raising the benchmark federal-funds rate to a range between 4.25% and 4.5%. This is the highest rate in 15 years.

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Analysts say that increased costs in the oil industry will put a strain on shale's free cash flow this year. Tubular steel, drilling rigs, and labor have become more expensive in recent years, and companies expect these trends to continue into 2023. This has caused headaches for shale executives, who are struggling to keep up with demand.
Potentially lower oil prices and company valuations this year could encourage producers to reorient cash flows to stock buybacks instead of reducing debt, Mr. Johnston said.