The Oil Industry Is Borrowing Again, But This Time It’s Different – Markets Insider

Two years ago, Wall Street banks were on their way out of a long-term relationship with the oil industry. Now, with oil prices over $70 for the first time in three years, big bond buyers are snapping up oil bonds once again.

Only there is a condition this time.

The Wall Street Journals Joe Wallace and Collin Eaton wrote this week that Wall Street was buying bonds from non-investment-grade U.S. energy companies, which took advantage of record low interest rates to raise some $34 billion in fresh debt in the first half of the year.

Thats twice as much as the industry raised over the same period last year. But investors dont want borrowers to use the cash to drill new wells. They want them to use it to pay off older debt and shore up balance sheets.

It makes sense, really, although it is a marked departure from how banks normally react to oil industry crises. The 2014 oil price collapse, in hindsight, may have been the last normal crisis. Oil prices fell, funding dried up, supply tightened, prices went up, banks were willing to lend again, and producers poured the money into boosting production.

Since then, however, the energy transition push has really gathered pace and banks have more than one reason to not be so willing to lend to the oil industry. With the worlds biggest asset managers setting up net-zero groups to effectively force their institutional clients to reduce their carbon footprint and with the Biden administration throwing its weight behind the push for lower emissions, banks really have little choice but to follow the current. Their own shareholders are increasingly concerned about the environment, too.

Yet business is business, and nowhere is this clearer than in banks dealings with the oil industry. Bank shareholders may be concerned about the environment, but they certainly would be more concerned about their dividendand part of that comes from income made from lending to oil. And the higher oil prices go, the more willing banks will be to lend to those that produce it.

When they were unwilling to lend to the oil industry, other lenders stepped in. Last year, alternative investment firms scooped up hundreds of millions in oil industry debt from banks that were cutting their exposure to the politically incorrect industry. Hedge funds and other so-called shadow lenders dont seem to have banks misgivings about profiting from oil and gas.

Now banks have mellowed towards oil somewhat, but it is an interesting twist that the current loans come with the condition of not boosting output. Again, it makes sense. For years, the shareholders of U.S. shale oil companies have been complaining about poor returns as the companies put everything into output growth. Now its payback time, and shareholders want their returns.

So do lenders, apparently.

Per the WSJ article, this year, bond buyers want to see companies repairing their balance sheets and delivering to creditors and shareholders rather than plowing money into new wells.

This, by the way, would strengthen the borrowers themselves, positioning them better for whenever they can afford to start boosting production again. This may happen before too long. The International Energy Agency said earlier this month it expected oil demand to hit 100.6 million bpd next year, and OPEC this week predicted that demand will top 100 million bpd in 2022. Thats a lot of additional oil, and some of it will come from those same non-investment-grade borrowers from the U.S. shale patch.

In the meantime, however, oil companies restraint is helping to keep prices where they are and add upward pressure on them. U.S. oil production as of July 9 stood at 11.4 million bpd. That was 100,000 bpd higher than in the previous week and 400,000 bpd higher than a year ago. It was, however, way lower than the 12.3 million bpd for the week to July 10, 2019.

Production restraint, then, is paying off in more than one way. On the one hand, it has kept prices highereven if some shale producers failed to benefit fully from them as they hedged their 2021 production too soon. On the other, these higher prices are making banks more willing to lend to oil companies again. On a third hand, the shareholders of these companies are finally being made happy with the new prioritization of returns and debt repayment.

The U.S. shale oil industry after the worst of the pandemic appears to have become leaner, again, but also healthier in terms of balance sheet strength. This is particularly true for those who are preparing themselves for a world where demand for oil would be much lower and prices would also be lower, according to industry insiders cited by the WSJ reporters. Investor interest in oil, then, is still alive and kicking, despite the ESG investment rush and all that. It is a simple example of the basic principle of how markets work: if there is money to be made from something, money will be made from that something, regardless of its reputational standing in the public eye.

By Irina Slav for Oilprice.com

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The Oil Industry Is Borrowing Again, But This Time It's Different - Markets Insider