How Debt Has Caught Up With US Shale

Whiting Petroleum is the latest victim of the flawed U.S. shale play business model.

The shale and tight oil play model is based on large-scale acreage acquisition at any price and massive over-production to satisfy growth targets. In Whiting’s case, it also involved debt-based acquisition of Kodiak Oil and Gas, another large Bakken player. The $3.8 billion deal closed in December 2014 when WTI oil prices averaged $66 per barrel, down from $106 per barrel in June.

Whiting’s demise shows that location isn’t everything. The company is looking for a buyer despite having a premium position in the Bakken Shale play in North Dakota.

Whiting discovered the Sanish Field in 2006 that began the Bakken-Three Forks play and that has been the centerpiece of activity for the past several years. The map below shows Bakken commercial areas at $45 WTI oil price based on an average well EUR (estimated ultimate recovery) of 650,000 barrels of oil equivalent.

The table below summarizes Whiting’s financial performance. The company ended 2014 with free cash flow of almost negative $3 billion and 100% debt-to-equity ratio. The increase in debt from 3rd quarter 2014 was because of the Kodiak acquisition.

Whiting is typical of many U.S. independent shale players that operate on perpetual negative cash flow and increasing debt. Investors ignored the poor financial performance of shale players as long as oil prices were high. Companies claimed high per-well profit margins when oil prices were in the $95 per barrel WTI price range despite negative cash flow.

Capital flowed to these companies because they paid premium returns for debt and equity offerings, often in the 6-9% range. In a zero-interest rate world, these yields were irresistible because the investments were in the U.S. and backed supposedly by a hard asset in the ground.

When oil prices began to fall in mid-2014, the share price of these and most energy companies dropped. In late August 2014, Whiting stock sold for $93 per share but closed at $34 on Friday March 6, 2015. When asset values fall below certain thresholds, debt covenants are triggered so Whiting must find a way to satisfy these calls. Selling the company was apparently the only option.

Whiting is a harbinger of the future for companies with a similar business model as long as oil prices remain low.