Much of the debt issued by shale operators has been high yield or what is commonly referred to as junk. According to the Wall Street Journal:
“Junk bonds have financed the U.S. shale boom, and now the sharp drop in oil prices could lead to a massive wave of defaults on that high-yield debt.”
Shale debt, falling prices and slack demand has tight oil producers in trouble. And yet, there is still burgeoning production. Why? Well, we’ve seen this before. It’s the shale debt redux. Operators did it a few years ago in natural gas and prices have yet to recover. Unfortunately cheap money in the form of debt can mean poor investment choices for businesses and for investors. But it can also lead to an aberrant market because operators deep in debt won’t curtail production even though it is glutted. Debt coupons simply have to be met.
The shale revolution has always been funded by massive debt. Operators who were drilling for gas back in 2009-2011 used debt extensively. And just like now, they overproduced. By 2011, supply exceeded demand by four times. Then prices tanked. It is curious that so few asked the questions: why did they produce so heavily and glut the market; and why did they continue to produce into a glutted market? The answer is really quite simple. Many couldn’t afford to pull back production to help stabilize prices. Had they done so, they would not have been able to meet their debt payments. So they kept pumping…and pumping…and pumping.
And now they’ve done it again. To continue reading…