Oil drillers counting on prices to remain stable through the summer had their hopes dashed as the second half of the year kicked off with a weeklong rout that has erased crude's gains for 2015.
Upstream oil companies had been on track to get a boost to their balance sheets as crude prices regained ground in the first quarter and stabilized in the second. But with banks set to reassess the oil patch in September, U.S. crude tumbled 7.7 percent on Monday as oversupply concerns tipped the scales and traders sold off long positions.
Crude prices had taken a pause throughout May and June, with U.S. benchmark West Texas Intermediate consolidating around $60 per barrel. It settled at $52.53 on Monday.
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To measure their health, banks average out the value of producers' reserves over the previous four quarters. Producers with weak balance sheets and heavy debt loads were depending on higher prices going into the September rerating period. As commodity prices fall, so does the value of producers' portfolios. The banks will cut the amount of money firms can borrow based on those lower valuations.
Small- and mid-cap energy companies had grown relatively optimistic as U.S. crude stabilized, said Bill Costello, energy and utility analyst and portfolio manager at Westwood Funds.
Costello expects banks to reduce drillers' borrowing bases by 15 to 20 percent after the determination period in September. Many producers will be able to shoulder that burden, but those with debt loads equal to four times their earnings or more will likely struggle, he said.
Westwood pruned its portfolio at the end of 2014, holding onto names with strong balance sheets that were able to extend their debt payments by four to five years, including RSP Permian, Bonanza Creek Energy and Synergy Resources. The fund sold off shares in those with heavier debt loads, including Rex Energy and Oasis Petroleum, both of which are sharply lower this week.
Exploration and production firms with debt coming due soon will likely run into problems, Costello said. "Even 2017 doesn't give you as much breathing room as you would probably like."