The doldrums of summer means it is time to harp on my favourite subject again.

No, not the Alberta government suing itself over power companies legally walking away from “more unprofitable” Power Purchase Arrangements, even though I may comment on that at a future date because it is actually quite funny.

And no, not the U.S. election or Donald Drumpf since on the advice of valued friends and colleagues, I have gone cold turkey on what was becoming a truly unhealthy obsession with the cheeto.

So none, of those.

What I do want to talk about is debt. Specifically the mind bogglingly large amounts of debt that remain outstanding in the energy sector globally, in the United States and in Canada. Or the amount of debt that sits like a pallet of melting fish guts on the balance sheets of sovereign oil producers, the largest integrated companies in the world, the intermediate producers like Canada’s independents and the tight oil sector and finally, the energy services sector.

The reason we need to continually revisit this concept is that all this debt is the ticking time bomb of the energy sector and while the day of reckoning appears to be imminent, it sometimes feels as if no one is paying attention.

It’s easy to blame the borrowers, after all they are the ones who levered up their balance sheets in the reckless pursuit of unneeded supply, but lenders and funds are equally complicit in this in their relentless search for yield. And standing off to the side, holding a lit water and wind proof match over a giant storage tank filled with overproduced gasoline are the world’s central banks, keeping rates at ridiculously stimulative lows and encouraging the very behaviour they decry.

How bad is it? Some stats to consider

• US Oil majors, which includes companies like Exxon Mobil and Chevron, carry an estimated $138 billion in debt, nearly double what they had at this time in 2014 and 10 times what they had in 2008.

• At the same time, capex is being slashed and cash flow is dropping. But the dividends aren’t being cut and in some cases (I’m looking at you Exxon Mobil) are actually being raised! Crazy!

• I saw a stat that said the emerging market oil and gas companies had an astounding $450 billion in outstanding debt as at the end of 2015 up almost 6 times from ten years earlier, most of it raised when oil prices exceeded $100.

• Banks are finally getting the message and have reduced their exposure to the energy space by some 6% so far this year, but… They still have an astronomical $2.19 trillion outstanding. This is on top of the estimated $2 trillion issued by Wall Street.

• Bankruptcies in the United States now number more than 90 since the beginning of 2015 and the pace of filings in the first half of 2016 is double what it was in 2015.

• Moody’s recently issued a report that suggested that the North American oilfield services industry faces a debt wall of more than $120 billion of loans maturing in the next five years with almost two-thirds of that debt held by companies rated as speculative or lower. It also estimated that about one third of the companies in the survey had Debt to EBITDA ratios in excess of 10. What this means is that in a deteriorated operating environment, refinancing will be extremely difficult except for the most solid companies and many companies will be unable to finance capex or working capital if the market does recover because they are so clearly already out of covenant. An interesting spill-over effect is that the much vaunted efficiency gains the producing companies boast of are likely over as the stressed oilfield service companies are not likely to reduce rates any further.

• On the subject of debt levels of producing companies, I also recently read that the average tight oil company operating in the US has a debt to cash flow in excess of 10 times. Put another way, it would take ten years for that theoretical average company to pay off all its debt, assuming it elected not to do any drilling, which is kind of why they exist. With typical bank covenants being 2 times (likely stretched in the current market), not one of the companies in the survey would have been in covenant, with the lowest ratio of 2.2 belonging to Exxon and the highest – 29 times! – belonging to Whiting Petroleum.

What does all this mean? It means that while prices have seemingly stabilized, we are not close to being out of the woods yet and that the deleveraging must continue lest the damage get worse.

Depressed yet? OK, just so we don’t get too doom and gloom on you, while there is a significant headwind from all this debt, there is also an equally impressive amount of equity capital going into or being allocated to the oil patch to assist in the ongoing deleveraging.

Case in point – in the public markets, the first half of 2016 saw more equity raised than in all of 2013 which was the previous high. Almost all of this equity is targeted at reducing leverage.

On the M&A side, deals are starting to accelerate and there is a significant amount of private equity capital and distressed debt funds on the prowl (estimated capital base of $100 billion) picking up significant assets from troubled companies looking to raise cash to pay down debt.

So it appears that saner heads are prevailing and hopefully we can escape the financing silliness that got us into this mess in the first place.

Until you read something this:

California Resources, which currently has a net debt to EBITDA of 8.5 times, just this week raised $1 billion in five year notes bearing an interest rate of LIBOR plus 10.375%. What? Oh come on!

Never mind the lunacy of the cost of funds to the company, who is the soon to be fired underwriter on the deal and what investor could possibly want to pick this up for their portfolio?

Prices as at August 12, 2016 (August 5, 2016)

• The price of oil ended the week up after last week`s slump
  • Storage posted a surprise increase
  • Production was down marginally
  • The rig count was up
  • The market reacted to vague Saudi commentary suggesting production management
• Natural gas fell sharply during the week, as traders took my bullish article from last week as a contra-indicator and sold aggressively

• WTI Crude: $44.63 ($41.97)
• Nymex Gas: $2.586 ($2.772)
• US/Canadian Dollar: $0.7720 ($ 0.7600)

Highlights

• As at August 5, 2016, US crude oil supplies were at 523.6 million barrels, an increase of 1.1 million barrels from the previous week and 70.0 million barrels ahead of last year.
  • The number of days oil supply in storage was 31.3, ahead of last year’s 26.8.
  • Production was up for the week at 8.445 million barrels per day. Production last year at the same time was 9.395 million barrels per day. The change in production this week came from flat Alaska deliveries and lower 48 production.
  • Imports continue to be elevated during the week to 8.404 million barrels a day, compared to 7.573 million barrels per day last year.
  • Refinery inputs were down marginally during the week at 16.597 million barrels a day
• As at August 5, 2016, US natural gas in storage was 3,317 billion cubic feet (Bcf), which is 15% above the 5-year average and about 12% higher than last year’s level, following an implied net injection of 29 Bcf during the report week.
  • Overall U.S. natural gas consumption fell by 1% during the week as cooler temperatures lessened power consumption
  • Production for the week was flat and imports from Canada fell 6%
• As of August 8, the Canadian rig count was at 111 (16.5% utilization), 78 Alberta (17%), 13 BC (17%), 19 Saskatchewan (16.5%), 1 Manitoba (7%)). Utilization for the same period last year was about 24%.
• Oil rig count at August 5 was at 396, up 15 from the week prior.
  • Rig count at January 1, 2015 was 1,482
• Natural gas rigs drilling in the United States was up 2 at 83.
  • Rig count at January 1, 2015 was 328
• US split of Oil vs Gas rigs is 82%/18%, in Canada the split is 52%/48%
• Offshore rig count was flat at 17
  • Offshore rig count at January 1, 2015 was 55

Drillbits

• Q2 results are coming fast and furious and the results are pretty much as expected. A lot of red with some positive thrown in just to confuse people.
  • Crescent Point funds from operations Q2/2016 of $404.4 million (Q2/2015 of $524.2) and net loss of $226.1 vs a loss of $240.5 in Q2 2015
  • Birchcliffe funds from operations Q2/2016 of $13.3 million (Q2/2015 of $45.8) and net loss of $24.3 vs a loss of $5.2 in Q2 2015
  • Kelt funds from operations Q2/2016 of $11.7 million (Q2/2015 of $14.7 and net loss of $20.4 vs a loss of $9.9 in Q2 2015
  • Peyto funds from operations Q2/2016 of $102 million (Q2/2015 of $135) and net income of $9.0 vs $12.3 in Q2 2015
• Suncor agreed to pay $50 million to get an interest in a North Sea oil project
• More pipelines were blown up in Nigeria (question – how many km of pipeline has been destroyed in Nigeria the last 5 years vs how many have been built in Canada?)
• Saudi Arabia mused publicly about whether there could be some production management discussed at an upcoming meeting in Algeria. Meanwhile, Saudi production contines to increase.
• Drumpf Watch – I know I said I would stop, but I can’t quit him! This past week Donald Drumpf suggested that supporters of the Second Amendment take matters into their own hands regarding Hillary Clinton. Aside from the fact that his stated “Second Amendment Movement” isn’t actually a thing, I suspect it has been a long time since a candicate has suggested physical violence against another candidate. Just raising the bar on outrage, each and every day…