Credit Downgrade Threat And US Energy Downturn: The Challenge Of Survival In The Oilfield

By Lorne Matalon
April 14, 2016
Lorne Matalon
This oilfield worker said he's grateful to still be working in a downturn. Hundreds of thousands of people in the energy industry have been laid off since the price of crude oil peaked in 2014.
Lorne Matalon
As of April 2016, the US rig count has fallen by more than 60 per cent since crude oil prices began trending downward in 2014.
Lorne Matalon
A frack operation in the Permian Basin near Midland, Texas. The Permian Basin of Texas & New Mexico was once a sea. The former seabed is laden with hydrocarbons.

MIDLAND, Texas --- Nearly a dozen west Texas cities, counties, hospitals and school districts are facing the possibility of a bond credit downgrade in the coming months by Moody's Investor Services, one of the country's "Big Three" ratings firms.

That's because those local institutions rely on energy-related tax revenue, which has fallen precipitously. And the possibility of a bond downgrade is a threat facing other oil and gas states as well.

In Texas and other energy-producing states, bonds are not an abstract consideration. They are used to build vital infrastructure such as roads, sewer systems, schools, mass transit and hospitals.

One such example in the Permian Basin is a state-of-the-art emergency room at Midland Memorial Hospital, finished in 2012. The hospital is within the Midland Hospital District, one of the entities on Moody’s watch list.

The money to build it came from bonds issued by the hospital. Were Moody's to cut their bond credit rating, as the agency warned might be possible in early March, these bonds would become much more expensive and, perhaps, riskier for investors.

"You can get lost in Moody's report around what's happening here,” said hospital Chief Financial Officer Stephen Bowerman. “But what their issue is, is very important,” Bowerman continued. “And that is the cold hard fact that our economy has cooled dramatically and very quickly it cooled in the last 12 to 18 months."

He said no new infrastructure is planned at the moment. But if Moody’s issues a downgrade, future construction might be more expensive. Bowerman says even without new building plans, pain in the oilfield reverberates here.

"And what that means for the hospital that's real for our operations is, there's more people that are unemployed, there are more people that don't have insurance, there’s more bad debt, people that show up in the ER they need care but they don't have the money to pay for the services that we are required to give them,” he explained.

Bowerman said bond ratings are doubled-edged. When the boom goes bust, the hospital may be subject to a ratings downgrade. By the same token, when the energy market was healthy and then surging, Midland Memorial Hospital built a new ER with bonds.

"We got the great rating that we had in a very, very hot economy. That really had nothing to do with the hospital's operations,” Bowerman continued. ”Our financial picture isn't dramatically different today than it was five years ago as a hospital operation. But what's changed is the tax base and the value of the minerals in the ground. They're not as valuable as they were two years ago."

The city of Midland, along with neighboring Odessa, are the unofficial twin capitals of the Permian Basin of Texas and New Mexico. Both are threatened with a downgrade. But well before Moody’s announcement, the City of Midland went on the defensive: cutting budgets and freezing new hires except for essential personnel like Fire and Police.

For that, the city may be in better shape. Moody's competitors say things aren't so bleak at the Permian Basin's biggest city. "For Fitch & Standard and Poor's, we've actually been able to hold our Triple AAA, highest bond credit rating that they have available,” said City of Midland spokesperson Sara Bustilloz.

"They (Moody’s) mentioned that our sales taxes are down, the oil economy is not looking great right now but that we have been able to weather the storms in the past and that they have faith that we're going to do fine this time as well," she said.

To get a sense of historical context, we spoke with Professor Joe Hahn. He tracks the energy markets at the McCombs School of Business at the University of Texas at Austin. He said bond ratings are a critical economic benchmark for entities wishing to build infrastructure. “It’s an issue for concern in the short-term certainly,” Hahn said. “But it’s nothing new. Boom and bust cycles in the energy industry have always gone on and they probably always will.”

Moody's will issue its final ruling for west Texas by early June. It has already recently issued either downgrades or negative outlooks for other energy states, including Oklahoma, Louisiana, North Dakota and Alaska-- all due to energy’s downturn.

But in every downturn, there are survivors who position themselves for recovery. The price of crude oil is down by more than 70 percent since the summer of 2014. And oil and gas companies once flush with cash have cut exploration and decommissioned up to two thirds of their rigs. Many companies have gone under and hundreds of thousands of people are out of jobs.

One person who is positioning his employer to survive in the severe downturn, and hopefully prosper after it ends, is Kenny Scudder, VP of Sales for Palmer of Texas.

His routine consists of constant travel from Texas to other energy states like Louisiana, New Mexico and Oklahoma. We accompanied Scudder to the oilfields of the Permian Basin of Texas and New Mexico, the country’s highest-producing field near Midland, Texas. It’s a windswept expanse of flat high desert flatland, and the oil and natural gas that are extracted here are part of an energy complex that represents a key driver of the U.S. economy.

Scudder was calling on some of his oil and gas customers and their contractors. Palmer of Texas makes storage tanks and separation equipment for oil and natural gas producers. Separation involves extracting crude oil or natural gas from underground rock formations. But right now, the energy business is hurting.

"I'm with a manufacturing company, and pain to us is less bookings, less revenue, less shipments,” he said.

But Scudder explained that the company has adjusted to position itself for energy's inevitable bounce back. "You downsize your workforce, you have pay cuts, you diversify into other areas other than oilfield areas, so as a manufacturer, that's what you do, you look for other avenues to keep your plant open, to keep your people busy so that when it does pick up back up again, you're ready to ramp back up where you need to be."

Palmer of Texas has diversified by makings filters for aquariums in places like SeaWorld. The company is also making storage tanks for a water reclamation plant in Los Angeles County, California. “One of the upsides of a downturn is if you have a strong balance sheet, if you've made wise investments during the last boom, you can still maintain your business and expand and get ready for the next upswing,” Scudder explained.

Scudder says he is fortunate in that he can diversify. The company kept cash in reserve during the boom and his storage tanks can be tailored to suit multiple purposes. But oil producers only have one product and for them, diversification is not an option.

I spoke with David McDow, a construction foreman for one of Scudder's customer’s contractors. He described the ordeal of a falling energy market in stark terms. "Really painful. Lot of people being laid off,” he said.

His hands speak to a lifetime of work in the oilfield. His face is burnished by the heat of oilfield operations and the Texas sun. "I'm fortunate that I'm not laid off but I've had to come, 500 miles from my home to work. Everybody's hungry. All of our competitors are hungry too just like we are. A lot of them will take jobs for nothing. And that makes it tough on everybody,” McDow said.

McDow says his 40-year career in energy has consisted of peaks and valleys. He said that he can at least visualize the next peak. "If you want to drill a well, right now's good time to do it. You know, everything, you can get a good deal on it if you've got the capital to work with."

Distressed companies here are selling off assets--- or themselves entirely--- to buyers from China and Mexico anxious to snap up a good deal. Major players like Chevron, Shell and BP are also making huge layoffs but analysts believe they’ll be stable financially once the dust clears.

Analyst Jordan Goodman said that even smaller players with cash in reserve will emerge stronger for the pain they're dealing with now. "You can thrive because you'll be one of the few left over when all of your competitors go under. So in the long run, the strong will get stronger. The weak will go bankrupt,” he said.

At least 51 American oil and gas companies have filed for bankruptcy as of early March, according to the Haynes and Boone, an energy focused law firm. But companies like Palmer of Texas-- and there are hundreds in Texas alone-- are hunkered down now with an eye on future profit.