What a downturn. It turns out that when you turn off the global economy some bad things start to happen. Our example today: oil. WTI Oil, the key benchmark for north America, going to negative US$37 for a barrel of oil yesterday was not very uplifting for anyone in the oil and gas industry. While this was a bit of a technical contract rolling issue (oil closed at $13.91 today), it is still an indicator of a market that is just not very healthy. Demand has sunk like a rock faster than supply can be taken off and it is causing all sorts of havoc.
Here we highlight three stories and three lessons so far:
1) Like most disasters there is usually some silver lining.
In this case the big storage problem has created a nice little cash bump for anyone who owns a tanker!
2) Remember that sometimes you just can’t trust the numbers and hopefully you find out before the tide goes out.
Recently it came to light that the Singapore oil trading firm Hin Leong Trading wasn’t quite up front about $800 million in oil futures trading losses.
and
Hin Leong Trading has been in a financial crisis in recent weeks due to trading losses on the back of its lenders withdrawing credit lines, the collapse in oil prices, the impact of the coronavirus outbreak on businesses, lack of hedging policies and existing losses on its books, the filing said.
It said Hin Leong Trading, or HLT, recorded a positive equity of $4.56 billion and a net profit of $78.2 million in its financial year ended Oct. 31, 2019.
"In truth, however, HLT has not been making profits in the last few years. HLT has suffered about US$800 million in futures losses over the years, but these were not reflected in the financial statements," Evan stated in the application.
The company “suffered about US$800 million in futures losses over the years but these were not reflected in the financial statements,” he said. “In this regard, I had given instructions to the finance department to prepare the accounts without showing the losses and told them that I would be responsible if anything went wrong.”
In this case we’re not talking about small potatoes, where they are “seeking a six-month moratorium on debts of $3.85 billion to 23 banks.” There are a lot of eyeballs that looked at this one. And yet it still happened.
3) Beware of leverage.
Like some posters on r/wallstreetbets, Whiting Petroleum has run into some leverage trouble. They announced its restructuring on April 1st. https://whiting.com/restructuring-information/ They have had a bit of a tough year, with their market cap, and expectations, peaking in January at around $700MM, only to drop along with WTI down to effectively zero.
But this sad tale started long before this year. Back in 2015 they were riding high with an $8 billion dollar market cap.
Oil has dropped, but there are also issues in natural gas world and liquids markets, but this is beyond the scope of today. What we draw attention to is their $2.8 billion dollars of debt and associated interest, plus asset retirement obligations, and leases, and and and…
Finding and Selling a Barrel of Oil
As we have talked about previously, oil and gas is a terribly hard business. You must continually find new barrels of oil (and gas/liquids). For modern shale plays the decline rates are 30%+, creating quite the treadmill for companies.
We cover how to calculate how much it costs to find a barrel here - http://www.canadianvalueinvestors.com/oil-and-gas-investing-101 In this case – they spent about $21 to find that next proved barrel. Note: We would encourage you to go back and do longer term analysis but for today’s story this is sufficient.
And in their 2019 report they talk about improvements in operating costs per barrel. But they also have to spend $4-5 dollars per barrel equivalent for their head office and all of the staff to make their nice looking annual reports. https://whiting.com/investor-relations/annual-reports/ And then they also have to spend another $4-5 per barrel produced for interest. Then you have the whole issue of actually having to repay some debt eventually or keep on growing (so you can lever up more of course!). That’s called making things tough. At the end of the day, almost every dollar that came from production went back in the ground with the hope of at least replacing barrel for barrel (plus interest)..