Volatile oil and gas prices have forced companies to file for bankruptcy at higher speeds than previous rates in order to seek protection from creditors. So far this year 26 companies with debt over $10.96 billion have filed for court restructuring. In comparison, 28 companies with $13.2 billion in total debt filed for bankruptcy in 2018. Most of these filings are Chapter 11 restructuring, meaning that the company and creditors agree on a financial restructuring plan to pay off the debt. Companies that have filed for bankruptcy include Sanchez Energy Corporation (OTCMKTS: SNECQ), Halcon Resources Corporation (OTCMKTS: HKRSQ), and Legacy Reserves (PNK:LGCYQ), alongside many others.
The main reason for this rise in bankruptcies is that oil and gas prices have remained depressed throughout 2019. Producers are faced with oversupplied markets, reduced margins, and high debt loads - all of which are placing considerable pressure on them. The U.S. - China trade war also is a factor as oil prices are highly sensitive to the trade economy. After President Trump's announcement on August 1 that he will be levying additional taxed on China, oil prices plummeted by more than 7%. Many investors have given up hope that any potential in rising commodity prices could save these companies.
One metric that is considered to be among the main indicators of the industry's financial stress is default rate on energy companies with junk - rated bonds. As of August, they have been defaulting at a rate of 5.7 which is the highest level since 2017, according to Fitch Ratings. Oil and gas companies are increasingly struggling to meet their debt payments and secure new funding. Investors have become more skeptical of the shale business model which has provided considerable pressure on these companies. Companies usually finance production growth by falling into considerable debt and betting that increasing oil prices will pull them out. However, as returns have proven to be meager in the past few years, investors have become skeptical and the total value of equity and debt offerings to shale companies has fallen drastically.
Previously, shale companies received financing from banks when they were in trouble. However, in 2016, financial regulators became concerned about overexposure to shale drillers and tightened lending standards after many went bankrupt when commodity prices dropped. Loans are considered at risk of default if total debt reaches more than 3.5 times EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization. Banks are now more willing to lend money to companies that keep debt from operations below 2.5 times earnings. This puts shale companies in quite a predicament because while operating at a lower debt to earnings ratio makes them less risky, they are unable to sustain the same growth and production levels which investors are still expecting them to deliver. Many private companies and smaller public drillers have been hit the hardest because of this.