ResiliencePublished on Resilience (http://www.resilience.org)
The Shale Sugar LickPublished by Energy Policy Forum on 2014-08-19
Original article: http://energypolicyforum.org/2014/08/13/the-shale-sugar-lick/ by Deborah Lawrence
A well known American comedian, Ron White, quips about the amount of sugar Americans eat by suggesting that certain restaurants install a sugar lick. Patrons can “belly up” and take their fill at the trough. Such an analogy might be apropos of some shale operators with regard to their addiction to debt.
A useful metric when evaluating a company is to look at the ratio between interest expense and operating income. A low ratio means that the company has not needed to borrow great sums of money to keep going. It generates sufficient cash to fund future operations without exorbitant levels of debt or shareholder dilution from issuing more stock.
Examining a selection of shale operators who are active in various plays in the US, one sees an interesting pattern. Perhaps it would be useful to define operating income. Operating income is gross income minus day to day costs of running the business including salaries and then subtracts depreciation. It is a metric that investors use to determine how much potential profit a company might generate. Obviously it gives a more accurate picture of a firm’s profitability than simply gross income because costs have been removed. But not interest expense.
Recently, the oil and gas industry’s appetite for debt has exploded primarily because cash is not being generated by the underlying business proportional to its needs. This is particularly true of some shale operators. EIA, the forecasting arm of the US Department of Energy, quantified this appetite for debt. EIA stated:
“The gap between cash from operations and major uses of cash has widened in recent years from a low of $18 billion in 2010 to $100 billion to $120 billion during the past three years.”
To demonstrate how this phenomenon translates to a company’s financial statement, one need only to examine the ratio between interest expense and operating income. The following chart shows the percentage of total operating income, or potential profit, that is being eaten up by nothing more than interest paid on debt at Range Resources, Devon Energy, Quicksilver Resources, Encana and Exco.
Shale operators have, indeed, parked themselves at the sugar lick debt trough for quite some time now. Could debt diabetes be right around the corner?
It is certainly not out of the realm of possibility.
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