The once-powerful partnership between fracking companies and Wall Street is fraying as the industry struggles to attract investors after nearly a decade of losing money.
Frequent infusions of Wall Street capital have sustained the U.S. shale boom. But that largess is running out. New bond and equity deals have dwindled to the lowest level since 2007. Companies raised about $22 billion from equity and debt financing in 2018, less than half the total in 2016 and almost one-third of what they raised in 2012, according to Dealogic.
The loss of that lifeline is forcing shale companies—which have helped to turn the U.S. into an energy superpower— to reduce spending and face the prospect of slower growth . More than a dozen companies have announced spending reductions so far this year, even as crude-oil prices have rallied more than 20% from December lows. More are expected to tighten budgets as they release earnings in coming weeks.
The drop in financial backing is especially being felt by smaller, more indebted drillers. But even larger, better-capitalized frackers are facing renewed investor skepticism about whether they can keep spending in check and still hit growth and cash-flow targets.
Shares of Continental Resources Inc. fell 5.4% Tuesday after the shale company, founded by billionaire Harold Hamm, disclosed that fourth-quarter spending was almost 10% higher than analyst expectations.
Wall Street support allowed shale companies to persevere through a plunge in oil prices that began in 2014, eventually helping the U.S. surpass Saudi Arabia and Russia as the world's largest producer of oil , with 11.9 million barrels a day in November, according to the U.S. Energy Information Administration.
Banks have provided financing when producers spend more cash than they take in from operations, something that has happened every year since 2010. They also help companies hedge their future oil production to lock in prices and avoid market volatility, and provide them with revolving loans backed by future oil and natural-gas prospects.
But in 2016, federal regulators concerned about banks' exposure to shale drillers tightened standards for lending to oil-and-gas companies after dozens went bankrupt amid the drop in commodity prices. The U.S. Treasury Department guidelines require lenders to regard loans as troubled if a company's total debt reaches more than 3.5 times a producer's earnings, excluding interest, taxes and other accounting items.
Many banks now prefer to keep operators below 2.5 times earnings, bankers and lawyers said. Still, 20 companies were at 2.5 times or higher in the third quarter, and the industry remained more indebted at that time than during the same period three years ago, according to S&P Global Market Intelligence.
"There was a frenzy back then to fund the next up-and-coming story," said Scott Roberts, the head of high-yield investments at Invesco Ltd., which has more than $800 billion in assets under management. "Too many people got burned, so the appetite for that is not there today."
With U.S. oil prices at about $57 a barrel, even a modest increase in the cost of borrowing is enough to wipe out any potential profits this year for some companies. Many companies don't have much wiggle room if they intend to meet investor demands for better profitability. And unlike a few years ago, shareholders have no interest in paying for unprofitable shale drilling.
While many shareholders have urged shale executives to live within their means—spending only the cash they generate from operations—they haven't welcomed announcements of declining production, cash flows or growth.
Shares in CNX Resources Corp., a small company that drills in Pennsylvania, are off more than 20% over the past three weeks after it announced spending reductions that some analysts predict will lead to output declines by the end of this year. A spokesman for CNX said the company expects production to rise as much as 6% from the fourth quarter of 2018 to the same period this year, as well as annually compared with 2018, even as it is cutting spending.
Concho Resources Inc., one of the largest operators in the booming West Texas region, fell more than 13% in the two days last week after it released earnings that failed to meet analyst expectations for cash flow. Concho also said it plans to cut spending 17% from previous guidance, a reduction that would lead to oil output growth of 15% from the fourth quarter of 2018 to the same period this year, instead of 25%.
The bond between U.S. producers and financiers doesn't appear to be completely broken, and the strongest shale companies continue to attract Wall Street backers. Industry bellwethers such as EOG Resources Inc. have begun to generate free cash flow and don't need outside funds. They also have locked up land for future drilling locations and have less need to pay out billions for new inventory, a significant source of capital demands in previous years.
"Late last year, the investment community had a more bearish outlook, even with great improvement in operating efficiencies," said Tim Perry, global co-head of oil and gas for Credit Suisse AG. "Yet recently the industry has performed well relative to other sectors, so the beginning of a recovery may be happening now."
Still, in the past six months, many companies have been punished after turning to capital markets to help pay for acquisitions or other strategic priorities. In 2016, such moves were welcomed by investors who favored expansion.
"We are seeing sources of funding dry up, with liquidity being harder to come by, particularly debt," said Regina Mayor, who leads KPMG's energy practice. "I don't think they have that kind of get-out-of-jail-free card like they had last time."