The oil and gas industry is in trouble seen by the latest restructuring attempt by Chesapeake Energy and this weekend that McDermott International is preparing to file for bankruptcy. As we talked about in today’s Market Call natural gas prices went below $2/MMBtu in today’s session during what should have been the strong season and with the frightening outlook that the US gas industry is running out of time to get “its” winter. The troubles are evident despite low rates and a world economy still in expansion mode. Five years of walking in the desert could the energy be close to an important inflection point with rising prices and profitability?
Structural break since 2008
One of the key observations in the global energy sector is rising cost structure in the sector. During the period 2003-2008 the sector delivered easily +15% return on equity (ROE) but post the financial crisis we observe a distinct lower profitability at equal oil price levels. Take today’s Brent crude price of $65/brl and compare the two periods. In the early period the sector delivered +25% ROE at these price levels whereas the most recent period the ROE has been closer to 5-10%. These returns are not enough to satisfy the required rate of return from investors given the general equity return required and then adding sector risks such as cyclicality risk, elevated credit risk, “black” energy discount etc. The sector is essentially destroying capital at current levels and investments made for new discoveries have also been reduced substantially.