The Financial Crisis Has Now Ended
Much of the pain of the financial disaster did not necessarily have its full impact as a result of the government's interventions. With a healthy economy those interventions will be withdrawn and the market will take over once again. This will cause any of the pain that was not felt in the past decade to be clearly present once more. Mostly in the form of higher interest rates. What those rates will be is unknown at this time, I would suggest anywhere from 7.5 to 10.0% which is the historical middle of the road. This sets up an interesting dynamic for those in western based economies. The government interventions were providing everyone with the time in which to clean house and get your finances in order. Personal and corporate alike. Here in Canada that’s not what I saw happen with most people. We’ve kind of created our own future housing crisis here. In oil and gas, they’re muddling through the most severe downturn ever. One that is of their own doing and one in which they’ve done nothing about.
For producers to face higher finance costs at this point will be difficult. North America may have to come to grips with the fact that much of their deliverability in oil and gas will be severely diminished in the next decade. Muddling along has enabled the producers to have about five minutes of resilience against any financial headwinds. Our sample of the 23 producer firms that we follow recorded the following performance during 2016. The total debt that they carry is $161.3 billion. Note this is just bank debt. Their total debts are $335.9 billion. On the bank debt they paid $8.8 billion in interest for an average interest rate of 7%. Interest rates paid by these producers varied from 3.46% to 25.79%. This interest expense represented 5.5% of revenues. The only conclusion that I would come to from this is that these companies are perfectly leveraged. It would seem the exact amount of debt is being used to offset the equity in order to earn a greater return on that equity. However, as I’ve noted regarding the recording of property, plant and equipment, these companies are not necessarily profitable.
Prime interest rates have been in the three to four percent range for the majority of the last few years in which these funds would have been borrowed. That producers are paying an effective interest rate of 5% shows they are paying somewhat of a premium. We also don’t know how much interest was capitalized to property, plant and equipment. Moving from 3 to 4% to 7.5% would be a doubling of interest costs for these producers. Doubling their interest expense. Affecting their cash flow by $8.8 billion and bringing it down to $27.4 billion for 2016. Maybe not as severe a hit as it would seem, however this would just be the pain felt from the operational side.
In terms of raising additional capital it would only become more difficult for the producers. The reduced cash flow would encumber their cash flow multiple knocking down their valuations by $50 billion to $165 billion. These producers stocks would also have to perform against the opportunity that investors may be purchasing bonds etc that provide returns on a guaranteed basis of up to 7.5 percent.
“The future belongs for those who prepare for it,” Ralph Waldo Emerson. After this weeks developments in oil and gas it should be evident to everyone that the producers remain in severe jeopardy. They have done nothing whatsoever to prepare, or to deal with any alternate reality in the development of their firms. It is their right to produce as much oil and gas as they feel they can at whatever time they feel they can do it. The accounting for capital costs over the past four decades has enabled them to see their business in the context of a profitable operation, which in reality these businesses are not commercial enterprises. Their view of the industry is distorted as a result. It is important to point out that People, Ideas & Objects Preliminary Specification, our user community and service providers provide the most profitable means of oil and gas operations. Why would that not be considered? Government support of the economy is about to cease and the survivors will be separated from those that are ill prepared. Adding another issue to an unprepared industry that is in the state that oil and gas is in will be difficult. Interest rates may not move too quickly but the investors will be taking them into consideration right away.
The Preliminary Specification, our user community and service providers provide the dynamic, innovative, accountable and profitable oil and gas producer with the most profitable means of oil and gas operations. Setting the foundation for North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy. And don’t forget to join our network on Twitter @piobiz anyone can contact me at 403-200-2302 or email here.