January 26, 2016 / 6:23 PM / 2 years ago

Energy earnings will hint at who survives crude's rout

NEW YORK (Reuters) - As crude prices crater, threatening a sizeable number of U.S. oil producers who are predicted to fail under continued global oil doom, the current earnings season will be an important window into who will be standing when the dust - and prices - settle.

A pumpjack brings oil to the surface in the Monterey Shale, California, in this April 29, 2013 file photo. REUTERS/Lucy Nicholson

The energy sector is expected to report a 74 percent drop in earnings per share in the fourth quarter of 2015 from a year earlier, and even that dismal view reflects the rosy days when oil was selling above $40 a barrel.

Currently hovering at $30 a barrel, oil is at a price that is unsustainable for most independent producers, Wells Fargo Securities said recently, naming companies such as Midstates Petroleum Co (MPO.N) and Sanchez Energy Corp SN.N that it said would need prices above $60 a barrel to break even.

To make it to a recovery that many say will not start until 2017, companies will have to have cash cushions, cost advantages and the ability to carry sizeable debts.

COST CUTTING “TO CLEAR STORM”

Most exploration and production companies now are spending more than $1 to extract $1 of oil, according to calculations by research firm KLR Group. Only four of 47 companies it tracked are above $1.10 in extracted product per $1 spent in the process; the median is below 70 cents on the dollar.

“Investors are looking at the relative finding costs and lifting costs to see who has the most cost advantaged operation, who’s prepared to clear the storm,” said Matt Kaufler, portfolio manager at Federated Investors.

For example, Halliburton (HAL.N) on Monday reported a better-than-expected profit as deep cost cuts helped offset a drop in drilling activity. Its stock fell 3 percent, compared to the 4.5 percent decline in the S&P 500 energy sector.

Virtually every company is cutting production, with fourth quarter revenues for the energy sector seen as having fallen 37 percent. But it is a clear danger sign when revenues are falling faster than production.

“That probably means they are losing market share as well as being affected by the downturn,” said Robin Shoemaker, equity research analyst with KeyBanc Capital Markets in New York.

Companies that have already put money into long-lasting wells can cut costs and be ready to bump up production if and when prices rise. But companies that have a higher percentage of their wells nearer the end of their useful life will have to pony up more capital sooner; another bad sign.

“Years of inventory that they can exploit going forward in a low cost fashion is certainly better than just having a handful of years,” said Kaufler, from Federated Investors.

CREDIT QUALITY IS KEY

To monitor credit quality, analysts will be looking at each company’s debt relative to how much it makes, net of taxes, interest, depreciation and amortization (a measure of earnings termed EBITDA).

Even companies that are doing well by some measures face debt problems. Halcon Resources (HK.N), for example, is bringing in more than $1.10 for every $1 it spends extracting oil, according to the KLR analysis. But it owes almost 10 times as much as it makes in EBITDA and has a “selective default” rating from credit agency Standard & Poor‘s, meaning it defaulted on at least one of its obligations.

More defaults and bankruptcies from the broader E&P group seem inevitable at current oil prices, said Jason Pride, director of investment strategy at Glenmede in Philadelphia.

“It’s too big of a move in oil prices for that not to occur.”

Reporting by Rodrigo Campos; editing by Linda Stern, Bernard Orr

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