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Page added on September 8, 2014
Drillers Piling Up More Debt Than Oil Hunting Fortunes in Shale
Floyd Wilson raps his fingertips against the polished conference table. He’s just been asked, for a second time, how he reacted when his Halcon Resources Corp. (HK) wrote off $1.2 billion last year after disappointing results in two key prospects.
Wilson once told investors that the acreage might contain the equivalent of 1.2 billion barrels of oil. He fixes his interlocutor with a blue-eyed stare and leans forward. At 67, he bench-presses 250 pounds (110 kilograms) and looks it. Outside the expansive windows of his 67th-floor executive suite, downtown Houston steams in its July smog.
He responds, unsmiling, with a one-syllable obscenity: “F—.”
Wilson has reason to curse, Bloomberg Markets magazine will report in its October issue. On the wall behind him hang framed stock certificates of the four public energy companies he’s built in his 44-year career. The third, Petrohawk Energy Corp., discovered the Eagle Ford shale, now the second-most-prolific oil formation in the country. He sold Petrohawk three years ago for $15.1 billion.
Then came Halcon. Since Wilson took over as chairman and chief executive officer in February 2012, the company’s shares have dropped by about half, trading at $5.67 on Sept. 5.
Halcon Resources Corp. Chief Executive Officer Floyd Wilson sold his previous company,… Read More
Halcon spent $3.40 for every dollar it earned from operations in the 12 months through June 30. That’s more than all but six of the 60 U.S.-listed companies in the Bloomberg Intelligence North America Independent E&P Valuation Peers index. The company lost $1.4 billion in those 12 months. Halcon’s debt was almost $3.2 billion as of Sept. 5, or $23 for every barrel of proved reserves, more than any of its competitors.
‘Uh-Uh’
Wilson is undeterred. “What do you do if you’re wrong? You go home and cry?” he asks. He shakes his head. “Uh-uh.”
A decade into a shale boom that has made fracking a household word and Wilson a rich man, drillers are propping up the dream of U.S. energy independence with a mountain of debt. As oil production hits a 28-year high, investors and politicians are buying into the vision of a domestic energy renaissance.
Companies are paying a steep price for the gains. Like Halcon, most are spending money faster than they make it, an average of $1.17 for every dollar earned in the 12 months ended on June 30. Only seven of the U.S.-listed firms in Bloomberg Intelligence’s E&P index made more money in that time than it cost them to keep drilling. (Results for two companies included only the first six months of 2014.)
Roughnecks connect pipe that’s attached to a drill bit 12,000 feet underground at a… Read More
Cash Shortfalls
These companies are plugging cash shortfalls with junk-rated debt. They owed $190.2 billion at the end of June, up from $140.2 billion at the end of 2011. (Six of the 60 companies that didn’t have records available for the full period weren’t included.)
Standard & Poor’s rates the debt of 41 of the companies, including Halcon’s, below investment grade, meaning some pension funds and insurance companies aren’t allowed to invest in them. S&P grades Halcon’s bonds CCC+, which the rating company describes as vulnerable to nonpayment.
Money manager Tim Gramatovich sees disaster looming in the industry.
“I have lent money to nobody in this space, and I don’t plan to. This thing is absolutely going to blow sky-high,” says Gramatovich, chief investment officer of Peritus Asset Management LLC in Santa Barbara, California. The firm manages investments of about $1 billion, including the debt and equity of oil and gas companies that aren’t drilling shale.
Proved Reserves
Halcon’s recent lousy run shows how quickly a bright future can dim. Like many of its peers, Halcon uses two sets of numbers to describe its outlook. To the U.S. Securities and Exchange Commission, the company reports what’s known as proved reserves.
The SEC requires an annual tally and limits these calculations to what the firm is reasonably certain it can extract from existing wells and other properties scheduled to be drilled within five years, based on factors such as geology, engineering and historical production.
To investors and lenders, Halcon also highlights a much higher figure that it calls resource potential. These estimates, while loosely defined by industry guidelines, don’t follow the SEC rule or timeline, as Halcon discloses at the beginning of its presentations. In fact, as Halcon notes, the SEC forbids companies from making resource-potential claims in official reserve reports. The agency doesn’t regulate what companies say at investor conferences, in press releases or on their websites. No one does.
‘Honored Tradition’
Discrepancies between proved reserves and resource potential are common in the industry, and investors can get duped, says Ed Hirs, a managing director at Houston-based Hillhouse Resources LLC, an independent energy company, who also teaches energy economics at the University of Houston.
“There’s a lot of ways to make money in the oil and gas business, and not all of them involve drilling for oil,” he says. “You just drill investors’ pocketbooks. When investors are willing to throw money at you, you can just make money on that. It’s a time-honored tradition.”
Halcon’s August investor presentation for EnerCom Inc.’s Oil & Gas Conference in Denver illustrates how far apart the figures can be. The company told investors it had resource potential equal to 1.3 billion barrels of oil. That’s almost 10 times the proved reserves it reported to the SEC at the end of 2013.
Asked in the July interview how much faith investors should put in resource estimates, Wilson says: “They shouldn’t put hardly any in them. They should just put in the idea that there’s some upside there. And if the practitioners are good at what they do or lucky, that upside might get turned into value.”
Spectacular Success
It would be easier to dismiss Halcon’s optimistic estimates if Wilson hadn’t succeeded so spectacularly in the past. Born on a U.S. military base in Georgia, he earned a bachelor’s degree in engineering from the University of Houston and started in the oil business in 1970.
Wilson says he made a poor employee, so he struck out on his own. He sold the first company he took public, Hugoton Energy Corp., to Chesapeake Energy Corp. (CHK) for $326 million in 1998, SEC records show. His second, 3TEC Energy Corp., was bought by Plains Exploration & Production Co. for $417.6 million in 2003, SEC records show.
Wilson moved on to Petrohawk in 2004, confident he’d sell the company in three years. When he didn’t, he led Petrohawk into new and untested shale plays. The gamble paid off.
Rewarding Shareholders
In 2008, while under shareholder pressure to cut spending and reduce debt, Wilson and his team made the discovery of a lifetime — the Eagle Ford formation, now pumping 1.5 million barrels of crude and 6.5 billion cubic feet (184 million cubic meters) of natural gas every day.
His sale of Petrohawk in 2011 to BHP Billiton Ltd. was the second-largest transaction in North America’s oil and gas industry in more than five years, trailing only Exxon Mobil Corp.’s $35 billion purchase of XTO Energy Inc. in 2010, according to data compiled by Bloomberg.
“I’ve done really well for all the shareholders every single time,” Wilson says. “Those numbers are out there in the public. I don’t have to prove it.”
Buoyed by the Petrohawk triumph, Wilson and his partners put up $55 million and took over Tulsa, Oklahoma–based RAM Energy Resources Inc. in February 2012. A further $550 million came from EnCap Investments LP, a private-equity firm that had previously backed Wilson. In honor of their recent success, Wilson and his partners renamed the company Halcon, Spanish for hawk.
Biggest Prospects
Six weeks later, in April 2012, Wilson told investors attending the Independent Petroleum Association of America conference at the Sheraton Hotel near New York’s Times Square that Halcon’s companywide resource potential was 1.4 billion barrels. The number was striking because it was 66 times higher than the proved reserves Halcon reported to the SEC in March 2012.
The Halcon slide show outlined the two biggest prospects: 875 million barrels in the Utica shale, which stretches across Pennsylvania, Ohio and West Virginia, and a further 306 million in the Woodbine in East Texas. Footnotes say Halcon had yet to drill a single well in either location.
Investors were eager to back Halcon. It raised $2.1 billion in bonds in the 12 months following the April presentation. The Canada Pension Plan Investment Board, a $227 billion fund that manages retirement assets for 18 million Canadians, paid $300 million for an 11.4 percent equity stake in October 2012. Mei Mavin, a spokeswoman for the pension board, declined to comment.
‘Really Excited’
As the months passed, Halcon had trouble turning the potential into proved reserves. Wilson sounded optimistic. During an August 2013 conference call, he says, “We’re really excited about our Utica/Point Pleasant asset.”
Wilson says a Halcon well was one of the most important in the play and, though some of its acreage was “goat pasture,” the company was preparing for full-scale development of the Utica.
Three months later, the company reported a write-off of $1.2 billion, largely related to the Utica and Woodbine plays. Halcon sold its Woodbine acreage for $450 million in February 2014. After almost two years of drilling, Halcon reported to the SEC in March 2014 that it had 16.4 million barrels of proved reserves in the Utica and Woodbine — the same acreage that Wilson had said in April 2012 contained the potential for 1.2 billion. The estimated bonanza had simply evaporated — eliciting Wilson’s four-letter obscenity.
“Resource potential, which means ‘Who knows?’” he says in the July interview. “But it’s possible. Resource potential down in the Eagle Ford of south Texas increased 10-fold over time. So our business can be rough. It can go either way.”
Blackland Prairies
Halcon’s latest prospects lie beneath the oak woods and blackland prairies north of Houston, in its El Halcon prospect, and under the arid plateaus of western North Dakota, where the company is drilling the Bakken shale. The two plays account for most of Halcon’s production.
Wilson’s biggest gamble is on 315,000 acres (127,000 hectares) of unproven Tuscaloosa Marine Shale, known as the TMS, a layer of rock stretching from Louisiana’s western border to southwestern Mississippi.
“It has to work for them,” says Leo Mariani, a senior analyst at RBC Capital Markets LLC in Austin, Texas. “If the acreage doesn’t work out and they can’t get the costs down, they’re going to be in big trouble.”
Engineering Challenge
Squeezing oil from the TMS is an engineering challenge. The formation is 2 miles underground through rock interlaced with rubble and sand. On a humid July morning, a sign in the red clay of Wilkinson County, Mississippi, announces Halcon’s Fassmann 9H-1 well. A Helmerich & Payne Inc. Flex3 rig rises above the clearing. A monitor in the air-conditioned supervisor’s trailer shows the drill bit has reached a depth of 12,000 feet (3,660 meters).
Progress is slow. In the rig operator’s cabin 30 feet up, one man steers a circulating bit screwed to the end of 2 miles of pipe, monitoring progress on a bank of flashing screens. The bit must pierce the TMS horizontally in the right spot. His margin of error: 5 feet.
Gibbous Moon
He misses. Frustration is thick as the temperature climbs to 91 degrees Fahrenheit (33 degrees Celsius). The hours slip by, measured in feet of pipe. As a near-full moon rises, a relief crew dressed in fire-retardant jumpsuits emerges, already sweating, from bunkhouses at the edge of the clearing. Heat lightning flashes in purple clouds to the south. It’s after 9 p.m. when a supervisor gets a message. The drill has veered off course. It’s time to try again.
At more than $13 million apiece, Halcon’s wells in the TMS are the company’s most expensive. Halcon abandoned its first well, the Broadway H1, after an underground casing failed. It has two producing wells in the play. Three others are in progress.
Wilson says Halcon has enough cash to keep trying and no imminent debt payments. Funds associated with Apollo Global Management LLC (APO), a New York–based private-equity firm, committed as much as $400 million in June to help Halcon pay for drilling in the TMS in exchange for a 12 percent return and a 4 percent royalty on what’s produced. That’s reduced to 2 percent after a threshold return has been met, Apollo says.
’Might Work’
“I don’t know how many times you can be wrong,” Wilson says. “I’ve never been wrong that many times. If your concept is that the Tuscaloosa Marine Shale might work or might not work, there’s a lot that feel that way in the industry. But there’s also quite a few that think it will work.”
Wilson doesn’t need to look far to see what happens when things go wrong. His office used to belong to executives of once-bankrupt electricity wholesaler Dynegy Inc. (DYN), which emerged from Chapter 11 in 2012. The custom wood paneling, fancy for his tastes, has been papered over with colored maps of drilling prospects.
Taken together, Halcon’s 1 million acres could cover Rhode Island. Wilson asks a visitor not to look closely; he doesn’t want to give away his next move.
Resource Potential
Wilson says proved-reserve numbers aren’t as important as the company’s resource potential.
“It’s what’s in the future that really matters to us,” he says. “So the resource potential is what we’re all about.”
If the TMS works, Halcon predicts an enormous payoff. In September 2012, a presentation for the Barclays Capital CEO Energy-Power Conference showed the resource potential of Halcon’s TMS properties equaled 373 million barrels of oil. Wilson says the estimate is much higher now. The company says it no longer gives resource estimates by play.
With the U.S. bent on energy independence and investors chasing riches from the fracking boom, there’s one other number to consider. Halcon’s proved reserves from the TMS reported to the SEC: zero.
15 Comments on "Drillers Piling Up More Debt Than Oil Hunting Fortunes in Shale"
Plantagenet on Mon, 8th Sep 2014 3:13 pm
Boom and bust is nothing new in the oil patch. Sell the boom, buy the bust.
MSN fanboy on Mon, 8th Sep 2014 3:57 pm
LOL, im sure they will find that never ending line of credit.
rockman on Mon, 8th Sep 2014 4:19 pm
A few critical facts worth understanding. First as far as investors in Halcon or any other company being INTENTIONALLY duped: it’s been understood for many decades that nothing will kill your drilling program faster than your own geologists falling in love with their own sh*t. Seriously: once we geologist really believe our analysis we can put a Mormon evangelist to shame when it comes to telling a convincing story because we really, really do believe what we’re preaching. And it’s not that uncommon for us to be really, really WRONG. LOL. I’ve only drilled two sure shot can’t miss wells in my career and they both missed.
Second, spending more capex than your income is not a measure of bad policy. Think about it: if you invest $1,000 and get a return of 20% (pretty dang good these days) what does that mean? You spend $1,000 the first 12 months and receive $20 income. IOW you spent 5X as much as you earned. Now think about the stat they threw out: spend $1.17 this year when you’re getting back “only” $1. IOW you spent $1,000 this year and only made back $855. That’s a good bit better than making $20 at 20% interest, isn’t it?
In my job if I spend $200 million of my owner capital and he received just $150 million back that year from those wells he would probably give me a multi $million bonus this Christmas. The term is “payback”: how long it takes to recovery the total investment. Essentially if I spend $1 million this year and produce $1 million worth of revenue it amounts to a 100% rate of return. IOW I’ve recovered 100% on my investment in a 1 year. But wells don’t tend to stop producing after 12 months. In the example above the wells make $150 million the first 12 months, then $120 million the next 12 months, then $90 million the next 12 months, etc, etc. Ultimately that $200 million investment generates $600 million in revenue.
This emphasizing how much capex companies are spending vs how much revenue they receive that same year is ridiculous. If Apple spends $300 million to build a factory making IPads and they only sell $200 million worth of tablets that first year is that a bad thing? Of course not. The critical question is if a company spends $X will that investment ultimately produce $X+ at an acceptable rate of return. In truth spending $1.17 to earn $1 the first 12 months and then to continue to receive revenue for some time beyond that first year sound pretty good, doesn’t it? What if those wells that generated the $1 the first year generate just $0.50 the next 12 months…and then $0.20 the next 12 months… and then $0.10 the last 12 months of its life? So the $1.17 investment generates $1.80 over its 4 year life: you just made $0.63 profit over that time. IOW your made 54% on your investment in just 4 years. Anybody here making that sort of return on their savings today?
So the stat they throw out as condemning current operations actually sounds pretty damn good. If fact, so good I tend to question its validity. It might be true but there’s no details offered as to exactly how that number was calculated. OTOH that’s one of the beneficial aspects of producing a fractured reservoir: while they may suffer a very high decline rate compared to a conventional reservoir they also tend to INITIALLY produce at a much higher rate than a conventional reservoir which, in turn, gets you to payout much faster and yields a higher ROR.
I do know there are companies losing their asses in the shale plays. I also know of companies making fantastic profits. Trying to make gross generalizations is pointless IMHO. You want to know how the shale plays are doing in general: analyze the details of every company drilling those plays and post a histogram. Good luck finding the data to do that: it would take an individual tens of thousands of hours to just come up with a very rough estimate. Folks can speculate to their heart’s content but no one can post facts to back it up.
rockman on Mon, 8th Sep 2014 7:06 pm
BTW you should notice that the management at Halcon had a lot of it’s own skin on the game: “…Wilson and his partners put up $55 million and took over Tulsa, Oklahoma–based RAM Energy Resources Inc. in February 2012.” IOW they were the original and only investors. And what about those unsophisticated investors at EnCap:”A further $550 million came from EnCap…a private-equity firm…” that had previously backed Wilson.” I know the folks at EnCap. My former company borrowed money from them to buy an offshore field about 20 years. Unsophisticated??? They are some of the sharpest cutthroats in the business. And I mean “cutthroat” as a compliment. Yep…they helped us do that acquisition. And netted a 22% return with almost no risk on their part with the way the “loan” was structured. They may have got sucked into a bad deal. But they weren’t novices by any measure.
Also every successful company I worked for borrowed much of the capex they spent during the good times: if you can borrow $100 million at 8% and drill wells if you can make a 14% return wouldn’t you take out the loan if you could? Of course, there is that big “if”. But that why it is referred to as “risk capital”. Don’t want to take a risk? Put your savings a money market and it back and don’t worry. LOL.
Makati1 on Mon, 8th Sep 2014 11:29 pm
The bubble is about to burst…
Nony on Tue, 9th Sep 2014 12:43 am
1. Investment during growth is normal and required. Of course capex will be higher than earnings then.
2. The $$ charts have different time axes. If you look at them both from 2011 to 2014, you’ll see the same % delta for debt as for bpd (about 33% increase).
3. Halcon is one data point.
4. Yeah, the potential reserves is misleading. But so is the proved reserves. After all, look how it grew.
5. A minority of their sample of companies have junk-grade debt. And for that matter, who cares. Junk bonds are compensated for the higher risk of default by a higher interest rate.
6. TMS is a tricky bitch with the rubble zone and all.
7. Utica is starting to take off in the dry gas window. I wonder where Halcon’s Utica acreage is.
MSN fanboy on Tue, 9th Sep 2014 4:29 am
“how long it takes to recovery the total investment”
And how long do shale wells last?
Davy on Tue, 9th Sep 2014 6:11 am
The oil sector is one of the TBTF sectors showing stress to our financial system with capex/earnings compression. This is precisely the equation for confidence compression to the system. “Then” add in the other sectors like auto, housing, and retail and we see a accumulation of compressed sectors. Currently the markets being rigged by algo’s, HFT’s, and central banks treat bad news as good news so this only pumps the markets. Yet at some point in the curve there will be a phase change of confidence with diminishing returns of market manipulation leaving this racket in tears as all Ponzi schemes eventually end. It is my personal hope this leads to a BAU crisis on a scale that changes attitudes and lifestyles. This is the “Last Frontier” of hope for some kind of orderly descent. If we can have a strong enough crisis but still hold the global ship together we may be able to reboot the collapse at a survivable level.
rockman on Tue, 9th Sep 2014 6:23 am
Fanboy – Exactly. If one wanted to give a much more accurate characterization of then shale economics they need to apply the same time honored method used by the oil patch for decades: NPV…Net Present Value. The easiest way to think of it is as negative interest rate. That rate is called the DR…Discount Rate. The industry commonly uses 10% but there is no hard rule. Usually calculated monthly but I’ll do it here annually: $1 of production the first year. If the well produces $1 on income the second year its NPV is $0.90 ($1 X 0.9). If it produces $1 the third year its NPV is $0.80. Etc. It should be obvious that production beyond 6 or 7 years has a NPV reduced to next to nothing. Beyond 10 years it virtually has no significant value.
So one adds up all the yearly calculations and you have the NVP of a well’s reserves. But understand the variables involved. First, one has to have a fairly accurate schedule of all the future production. If one uses $1 for the production produced in Year A but it turns out to be $0.80 you’re off. Second, you assume a certain price expectation: oil will be selling for $100/bbl in Year B but it eventually sells for $92/bbl so your NPV is wrong. But this is still the best way to characterize production (and calculate the true rate of return) we have.
And this is where the high initial production rates of the shale wells are so beneficial: the NPR of the first 2 or 3 years when the well produces a large percentage of it URR yields a much higher NPV. But consider a conventional reservoir that might produce the same URR as a shale well but does it slowly such that half of its URR is produced after Year 8. The NPV of that Year 8+ production is very small. It might not seem fair to discount long term reserves so harshly but think in terms of you loaning me $100. I agree to pay you back $200. Sounds good until I point out that I’m going to give you that $200 at a rate of $10/year. So would you make me such a loan given the ridiculously low interest rate you would be getting?
But while NPV might be the key to calculating the industry rate of return consider this: when Ghawar was discovered the NPV calculated then for the production coming from the field today might be less than $1/bbl compared to the cash flow based upon $90+/bbl the KSA is receiving today. And as I’ve pointed out before cash flow is King in the oil patch…often time more important than ROR or even profit. And this is where the shale plays suffer: while they have very little future production that would be discounted significantly by the NPV calculation they also have very little cash flow in those future years. Which is just another way of explaining why the shale playing pubcos have to keep drill shale wells as fast as possible: they don’t establish long term cash flow of any significance. What the industry is desperate for is long term oil production at modest rates.
And that, children, is a lovely fantasy that’s nearly impossible to fulfill today.
JuanP on Tue, 9th Sep 2014 8:41 am
Thanks, Rock. I really appreciate the info you provide on the subject. 🙂
Nony on Tue, 9th Sep 2014 9:20 am
It’s actually much easier to turn on/off production of shale wells than of long term projects like Caspian or ultra-deep offshore or Arctic. So, the time horizon is more of a feature than a bug.
shortonoil on Tue, 9th Sep 2014 9:29 am
To get a verifiable feel for profitability in the shale industry, we took a look at the production of 4,598 producing wells in the Bakken. This comes from the IHS data set, and is the same data that Dave Hughes presents in Drill Baby Drill.
Of the 4,598 wells reviewed, average IP (initial production) was 467 barrels per day. After 10 years the average well output falls to less than 30 b/d, and we considered that to be the extend of well life, and the potential for increasing full well life cycle profitability. Over its ten year life span the average well in the study will produce 259,202 barrels. The first year’s production is 107,967 barrels, or 41.7% of the well’s full life cycle production. Assuming prices remain constant, 41.7% of the well’s full life time revenue is generated the first year.
Using straight line depreciation over a 10 year life span, assuming variable costs per unit remain constant, and fixed overhead per unit remain constant, if a well can not show a profit in its first year, it can not show a profit over its full production life cycle.
The rapid decline in the rate of production for these wells, 70% (from 467 to 139.4 b/d after one year) insures that insufficient revenue will be generated in subsequent years to produce a full life cycle profit if a one can not be achieved in its first year.
http://www.thehillsgroup.org/
Bob Owens on Tue, 9th Sep 2014 12:55 pm
I hope these debt problems scale up real quick and cause these companies to scale back. It is time they sobered up and their investors took their losses.
rockman on Tue, 9th Sep 2014 2:24 pm
Bob – Actually when I look back on my 40 years just the opposite has often been true: if the credit line is available companies will borrow every last penny to often drill worse projects then they had been drilling previously because that’s all they have immediately available. I once had a project transferred to another division because I refused to drill it because it was a piece of crap. But the managers knew the company was on the verge of failure and wanted to toss a “hail Mary” pass.
It’s similar to the “publish or perish” mandate some college professors face. If you borrow to the hilt and hit some wells you keep your job. If you borrow to the hilt and don’t drill a bunch of good wells you loose your job. And if you don’t borrow excessively preserving company capital and don’t drill a bunch of good wells you loose you job.
IOW two of the three possibilities get you fired. So which door would you pick to look behind? LOL
Nony on Wed, 10th Sep 2014 12:39 am
shale drilling is actually a lot lower risk than other ventures. The oil comes out pretty fast (iow the decline rate is high)…so price uncertainty is less of an issue. It’s got less political uncertainty since it’s in the U.S. There are hard assets. Etc.