Rice Energy's bond offering this month was rated CCC+ by Standard & Poor's, seven steps below investment grade, or the level above which some institutional investors, such as pension funds and insurance companies, are allowed to buy. S&P says debt rated in the CCC range is "currently vulnerable to nonpayment" and, in adverse conditions, bonds with that grade aren't likely to be repaid. Even so, Rice Energy was able to borrow at 6.25 percent. That compares with 9.5 percent for other bonds with similar ratings, according to Bank of America Merrill Lynch index data.
Some companies have been able to drill themselves to better credit ratings. In December, Oklahoma City-based Continental Resources Inc. (CLR), the most active driller in the Bakken, had its rating boosted from junk to Baa3, the lowest tier of investment grade, by Moody's Investors Service. Others, such as Chesapeake Energy Corp. (CHK), have made changes that improved their standing with credit-rating companies. Chesapeake, based in Oklahoma City, has sold off $16 billion in assets in the past two years, cut spending and refinanced debt, and S&P said it's considering a higher rating for the company.
By contrast, Forest Oil Corp. (FST)'s recent battering shows how the borrow-drill-repeat strategy can backfire. Forest sold $1.3 billion in assets in 2013 to help finance its drilling. Then in February the Denver-based oil and gas producer reported disappointing well results from its marquee assets in the Eagle Ford. Forest didn't have enough money coming in to keep from running afoul of its debt agreements. Both S&P and Moody's cut the company's credit outlook to negative.
Forest's bonds plunged. Its $577.9 million of outstanding 7.25 percent notes due in 2019 traded at 88 cents on the dollar on April 22, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority, a drop from this year's peak of 98.4 cents on Feb. 24. The notes are now yielding 10.31 percent, up from 7.6 percent. Larry Busnardo, head of investor relations for Forest Oil, didn't return calls seeking comment.
"This is a melting ice cube business," said Mike Kelly, an energy analyst at Global Hunter Securities in Houston. "If you're not growing production, you're dying."
Of the 97 energy exploration and production companies rated by S&P, 75 are below investment grade, according to the credit-rating company. The average yield for energy exploration and production companies rated junk has declined to 5.4 percent from 8.1 percent at the end of 2009, compared with a drop to 5.21 percent from 9.06 percent for all companies rated below investment grade, according to Barclays.
Cheap debt, along with advances in horizontal drilling and hydraulic fracturing, or fracking, have propelled U.S. oil output to a 26-year high. Last year, the country produced 87 percent of its own energy, putting it closer to independence from foreign sources than it has been since 1985, according to the Energy Information Administration.
It's an expensive boom. About $156 billion will be spent on exploration and production in the U.S. this year, according to a December report by Barclays analysts led by James West. That's 8.5 percent more than last year and outpaces this year's expected 6.1 percent growth in global expenditures, the analysts said.
"Who can, or will want to, fund the drilling of millions of acres and hundreds of thousands of wells at an ongoing loss?" Ivan Sandrea, a research associate at the Oxford Institute for Energy Studies in England, wrote in a report last month. "The benevolence of the U.S. capital markets cannot last forever."
The spending never stops, said Virendra Chauhan, an oil analyst with Energy Aspects in London. Since output from shale wells drops sharply in the first year, producers have to keep drilling more and more wells to maintain production. That means selling off assets and borrowing more money.
"The whole boom in shale is really a treadmill of capital spending and debt," Chauhan said.
Access to the high-yield bond market has enabled shale drillers to spend more money than they bring in. Junk-rated exploration and production companies spent $2.11 for every $1 earned last year, according to a Barclays analysis of 37 firms.