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As oil plunges, bankruptcies loom for private equity portfolio companies

·4 min read

(anatoliy_gleb/iStock/Getty Images Plus)
Oil has plummeted to its lowest levels in nearly four decades. And some small crude producersmany of them backed by private equitystand to lose the most.

The price on the May futures contract of West Texas Intermediate, the US benchmark crude, closed at a new low of minus $37.63 a barrel—down some 300%—Monday. Crude barrels were priced at more than $60 apiece in January.

This latest price dip could spell doom for many US oil producers, since it's nearly impossible to turn a profit at $30 per barrel, much less sub-zero prices. Those most likely to face bankruptcy are small independent producers, which operate under higher capital costs than integrated giants like Exxon Mobil or BP.

More coronavirus news: Continuing coverage from PitchBook

Lex Hochner, a managing partner at Houston-based Pickering Energy Partners, said he never really considered the possibility of oil futures turning negative per se, but that it wasn't "totally inconceivable." He expressed concern that oil and gas companies with leverage on their books may experience stress.
"It's not a good performance mark for us, in any event where we're facing situations where there's restructuring or bankruptcy in our portfolio," Hochner said. The firm isn't currently dealing with any ongoing restructuring.  
Now that oil has slumped, sellers must pay buyers to unload it. With an overflowing oil supply and disappearing storage options, investors are playing hot potato with May crude future contracts due Tuesday. Ultimately, these contracts result in physical barrels delivered to buyers. 
"Everyone who's in these contracts who thought oil would rebound by now, they're just dumping everything as there is no one to take delivery; they're dumping all their contracts," said Nizar Tarhuni, PitchBook's director of research and analysis.
Looking ahead, June's oil contracts are still trading at over $20 per barrel, indicating that the long-term picture might not be as bleak as the present. But that price is still remarkably low. And if oil demand continues to remain weak as a result of the pandemic, a late contract sell-off could repeat next month.

"This structural scenario of the oil industry nowadays, I've never seen anything worse," Tarhuni said.

Though overall private equity investment in oil and gas has slid since a recent peak in 2017, firms nonetheless poured a hefty $64.2 billion into the industry in 2019, according to PitchBook data.
While larger private equity firms that invest in oil alongside other sectors will likely be able to weather the storm, smaller energy-focused private equity firms are in a tough spot.

Small producers often turn to private equity firms for financing, since the industry requires expensive infrastructure and overhead costs that can be difficult to shoulder alone. Thus, it's likely that bankruptcy filings and subsequent production shutdowns will soon stain portfolios.
Despite the deeply uncertain future ahead for energy investors as portions of their portfolios may face bankruptcy, oil deals won't disappear as a result of this crisis. Rather, many investors may shift their strategy to distressed credit investing, Tarhuni said.
"While bankruptcies are expected, private equity investors will come in through the credit markets and find ways to take over entire businesses that way," he said. "And you'll see a lot of companies come out of bankruptcy as well, that'll get bought by private equity in distressed situations for pennies on the dollar."
Though this is far from a simple "buy low, sell high" situation, firms with access to capital may be able to scoop up deeply discounted assets and sell them for a profit years down the line, Hochner said. He added that the firm may use a portion of its about $300 million in dry powder to go on the offense.

"There's very few investing firms with large pools of capital or access to capital that are willing to wade into the energy industry right now," he said. "And so having access is probably the most valuable asset an investor has today."

4/21/20: The story was updated to clarify that Pickering isn't currently dealing with any ongoing restructuring, and that the firm's dry powder may be used to buy discounted assets, rather than alleviate bankruptcy situations.