Two years of spending discipline and paying down debt have let shale gas drillers cut the cord between their capital-intensive operations and their banks, leaving the sector less vulnerable to coming interest rate hikes proposed by the Federal Reserve, analysts said.
The Federal Open Market Committee, a committee within the Federal Reserve System, raised its benchmark interest rate by a quarter percentage point in March and hinted in its minutes that it may continue interest rate increases in increments of 0.5% per month for several months to choke off inflation. The Fed has not raised rates that quickly since 2000.
An increase in the federal funds rate would trickle down through the credit products used by exploration and production companies, or E&Ps. Oil and gas E&Ps were heavy users of credit products, primarily revolving lines of credit and bonds, throughout the shale gas boom of the past two decades. They needed to borrow heavily to pay upfront costs for land, labor and rigs, with cash from oil and gas sales coming later and with the amounts dictated by commodity markets. With the industry in "land grab" mode — leasing land and drilling expensive horizontal wells as quickly as possible — most E&Ps borrowed more money than they brought in, leaving them vulnerable to the banks and to commodity markets.
"The combination of very supportive commodity prices and capital discipline means many producers have little to no borrowing needs," Charles Johnston, senior analyst for high-yield oil and gas issues at credit research firm CreditSights, said in an email. "Additionally, the high-yield issuers repaid floating rate debt and conducted liability management exercises throughout 2021 to clear our maturity runways to 2025 or later, reducing refi concerns."
Johnston's colleague, Jake Leiby, senior analyst for investment-grade oil and gas companies, said, "Refinancing needs are low with most companies planning to use free cash flow to pay off maturing bonds rather than tap the market to refinance."
Most of the sector's first due dates are spread out over the next four years, according to S&P Global Market Intelligence data, a sharp contrast to August 2020 when due dates were more compressed. In August 2020, gas drillers had $7.7 billion coming due in 2025 alone.
By slowing the pace of drilling and production over the last two to three years, achieving positive cash flows by spending less and using the extra cash to pay down and pay off debt, shale gas drillers are expected to be swimming in cash this year. Natural gas prices are up from roughly $2/MMBtu in 2020 to more than $6/MMBtu now.
"With crude oil prices now 40% higher than in the first quarter of 2021 and natural gas prices nearly 30% more than in 2021, cash flows for E&Ps should remain robust in 2022," Oil & Gas Financial Analytics LLC founder Nick Cacchione said April 22. "This leaves even more cash flow to be allocated to shareholders via dividends and share repurchases and more funds available to retire debt."
At the start of 2022, S&P Global Ratings said that while oil and gas producers would return the bulk of their increased cash flows to shareholders, they would repay what they owed and hold off on borrowing more.
"We still believe issuers, by and large, will be averse to increasing debt leverage, given lessons learned in previous cycles and investor disdain for increased debt and negative free cash flow," Ratings team leader for oil and gas Thomas Watters said in a Jan. 25 note previewing the year. "Producers will continue to remain disciplined in their capital spending."
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