Fossil Fuel Companies Are Beginning to Fall Behind on Their Loans

Flames from the Maria fire burn through an oil field in Santa Paula, California late on October 31, 2019.
Flames from the Maria fire burn through an oil field in Santa Paula, California late on October 31, 2019.
Photo: Josh Edelson/AFP (Getty Images)

The oilpocalypse continues. The industry has been in a tailspin since the coronavirus lockdowns drove demand into the ground. Fossil fuel companies have scrambled to figure out what to do, and it seems the latest tactic is not paying loans.

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On Tuesday, Wells Fargo posted a quarterly loss for the first time since 2008, which isn’t exactly a comparison that inspires confidence. Within its report on the second quarter, Wells Fargo noted that the oil and gas industry is in particular trouble. Despite making up 3% of its loan portfolio, 47% of the second quarter delinquent corporate loans were tied up with oil and gas companies.

All told, the industry is past due on $1.4 billion, and the Wells Fargo report projects it could get worse. The report also helpfully points out that $3.9 billion in oil and gas loans are “criticized,” which is bankspeak for loans that are in danger of not being repaid. Keep in mind, this is only one bank, but things aren’t looking too great elsewhere.

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JPMorgan saw its revenue fall 70% in the first quarter this year, in part due to dip oil prices. Oil and gas companies are also writing down their assets because they simply can’t do the thing they do, namely extract dead dinosaur goop out of the ground. The biggest problem is nobody wants their oil, and prices are in tough shape.

After briefly going negative earlier this year, the price of oil has rebounded a bit. Just not to levels needed to make drilling profitable. The Kansas City Federal Reserve Bank saw oil production dip sharply last quarter in the region it looks after as well. That region covers a huge swath of the Midwest and Southern Plains, including all of Oklahoma, one of the epicenters of the fracking boom. Companies included in its survey said they would need oil to get up to $51 per barrel to be profitable. That’s not really happening, though, with oil camped around $40 per barrel. That means more companies are at risk of defaulting on loans or laying off workers to cut costs, something even massive companies like BP are doing. Or both.

It also raises the chances that we could in fact see banks get in the oil business themselves, taking over the fossil fuel companies that default. Wells Fargo was among a group of large banks scheming to do just that in April. It feels like a lifetime ago, but the prospect of bank-owned oil and gas companies is now a good bit closer to the horizon.

I’m all for collective action when it’s people against oppressive systems. But I have to be honest, I’m not really sure how I feel about this one. It’s the opposite of whatever asking someone to choose their favorite puppy is. On the one hand, fossil fuel companies have engaged in a campaign of deception and delay and funded politicians to do their bidding. On the other hand, banks. I mean, what else is there to say?

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Whatever comes next, it’s clear the current environment is unsustainable (even aside from the whole oil and gas industry ushering in a climate catastrophe). Oil and gas, particularly producing it through fracking, has never been a great investment. Now, the risk is rising for companies to default on loans, go bankrupt, and otherwise throw a wrench into the financial system as well as world energy markets. If only there was some way to transition the world away from these terrible investments and also stave off the destruction of life as we know it.

Managing editor, Earther

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DISCUSSION

I used to work in the industry, and gleaned a few things.

TL;DR: Recent Oil and gas financing created a false promise of glorious profits, but debt money doesn’t guarantee real money, and it has started crashing down like an investment in Bernie Madoff.

From my understanding (longer explanation):

Oil and gas companies learned in the Aughts not to peg their revenues to commodity prices. Many of the contracts, at least in the midstream section, are fee-based and insulated them from price fluctuations. But revenue still relied on how much gas was being produced.

Fracking produces a much bigger initial production than a regular well drill. So, with revenue leaning more towards the volume produced and not what a barrel was trading at, fracking took over as a preferred method of production.

Fracking also requires significant up-front capital, and the spike in initial production doesn’t always cover the cost. Which means a borderline Ponzi scheme of trying to pay for the previous wells with the spike of initial production from a new well. (Check out the Boomtown podcast, chapter 9.)

All that drilling requires lots of money. And debt is cheap, easy money...because it only has to theoretically pay back to debtor over time with future cash flows.

Private equity companies saw lots of potential to make big returns by getting a lot of loans to build their oil and gas assets, then hope to sell to a bigger fish.

Many of the loans have covenants attached to them that, if not maintained, require significant portions of the loan to be paid back. In my specific experiences, the company had to show certain EBITDA percentages to stay on target, for example.

There was always a push to capitalize costs as much as possible, because then instead of showing as an expense (and hurting EBITDA), the cost went “below the line” to depreciation. Keep building, keep capitalizing, and you won’t default on your loan.

All this to say: the situation isn’t good for anyone, and the climate catastrophe is as much the finance people’s fault as the drilling companies themselves. Chances are the oil and gas firms don’t have the assets to cover their loans because they’re over-leveraged. They’ve tried chasing more and more volumes of product to keep up revenues, creating a glut of supply and screwing over the environment (and the rest of us) by pushing for more and more consumption of petroleum products. All because a bunch of finance folks guessed at the “risks” with a spreadsheet, handed out debt money, and when the cash flows don’t show up to cover the debt...and it will definitely hurt.

I wish I could say, “serves them right,” but my experience tells me, anyone in finance never ends up paying the real price for their own mistakes.