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Petrotrin’s last stand

Thursday, September 14, 2017

It may very well be too little too late for Petrotrin, given the current cash flow position of the company. The real pain point will come with the refinancing of a US$850 million, bullet at maturity bond, due in 2019. Having seen its cash flow drained by a number of poor decisions going back over a decade—and with the government positioned to absorb this debt—a stark reality awaits the company.

Before going further, there is a tangential point related to how things interlock in the world of finance and the fact that there really is no free lunch.

The Petrotrin Bond, in question, was issued in August 2009. The coupon on the bond (interest rate) was 9.75 per cent. Compare the bond issued by Petrotrin in 2006 which was for 15 years and was issued at a rate of six per cent.

In 2009, the world was just coming out of the global financial crisis so the cost of capital was quite high.

Add to that our situation in 2009, with the uncertainty surrounding the collapse of CL Financial. The result was an extremely high rate of interest on the 2009 bond compared to the 2006 even after taking into account the different characteristics of the 2006 bond.

To the extent that the CL Financial debacle influenced T&T’s credit position in 2009 then there is a premium embedded into the Petrotrin 2019 Bond that reflected the country’s risk profile at that time and this is an additional unrecorded price that T&T ended up paying for the CL Financial situation.

We are now at what is presumably the end game. There is no way out of the current scenario except through a restructuring of Petrotrin’s operations which is a precursor to restructuring its debt. The challenge is that we may have left it too late. We have under two years to go.

Two years in office, two energy ministers, two committees charged with the responsibility for producing restructuring reports and two boards later the needle has hardly moved and we are now at a point of seeming crisis.

During this intervening two-year period, most international operators have significantly reduced their cost of production in order to remain competitive in the new oil-price environment.

Petrotrin needs to improve its cost structure and increase production but, at this stage, the company would simply be playing catch up.

Tough decisions need to be taken but the specifics of those decisions are still to be determined. There are, however, a set of circumstances internationally that could provide the company with a window of opportunity, albeit a very small and tenuous one.

BHP woes

Even though it has not received much attention locally, the decision by BHP Billiton to sell its interests in US shale caught my attention. Part of the reason was it was just in April of this year that BHP announced it was moving some of its accounting functions from Houston to T&T. From the announcement one could deduce this also included the accounting related to the shale oil business segment. The timing of a sale just a few months later seemed curious.

A bit of background is important at this stage. Oil prices since the turn of the century moved from around US$20 per barrel to as high as US$150 per barrel. A credit-fuelled economic expansion in the western world and in China created an unprecedented demand for crude oil during this period.

Add to that global supply was negatively impacted by a war in Iraq, an embargo in Iran and the Libyan revolution as part of the “Arab Spring”.

Post the financial crisis of 2008, cheap sources of debt allowed for riskier investments as low-cost capital translated into fairly low hurdle rates on that capital. This in aggregate gave rise to the shale revolution that initially offset the supply constraints up until around 2014 and from then on actually resulted in a supply glut where oil prices subsequently collapsed.

In 2011, BHP Billiton entered the shale market and, over the next couple years, invested around US$50 billion into this shale acreage. Oil prices topped out shortly thereafter and as BHP indicated in their announcement to put shale on the block “the shale acquisitions were poorly timed and we paid too much and the rapid pace of early development was not optimal.”

Having already taken significant write downs on their shale assets analysts expect assets that are on sale to garner a price of between US$7 billion and US$10 billion. Whether the market comes in at the higher valuation—obviously BHP’s preferred position—or at the lower end is an important dynamic going forward.

Distressed shale

The US shale oil story is an interesting one. Most focus on the production side and point to the fact that US oil production has accelerated and that shale would have at various points accounted for 50 per cent of that production level. The singular focus has been on growth and production. However, from the perspective of a financial analyst, there is another component and that is one of cash flow.

The business model of shale oil is one of a highly leveraged mining operation where the resource is depleted at a rapid rate.

Given the new technology, shale oil was quite expensive to produce. So from inception, the operations were at a loss. As losses mounted, the objective was to raise additional equity but consistent losses in subsequent years only meant that new equity had to be raised each time.

With new equity being eroded by losses and the valuation of reserves impacted by rapid depletion and lower oil prices, balance sheets were consistently under pressure.

Continuous and, in many instances, increased production meant new debt also had to be obtained in order to provide the financing to keep the cycle going.

In order to service the debt, many producers simply had to keep producing to generate cash flow. You will appreciate that, at some stage, the industry has a real risk of running out of cash.

The sale of the BHP assets and the price that it fetches on the open market would give an indication as to how this scenario is viewed on the ground. It is one thing to have an analyst view and it is another thing for an operator to put capital to work. Either way, the signal to the market would be much clearer.

The bottom line is that T&T need to be alive to these scenarios and position ourselves so that we can take maximum advantage if these circumstances were to materialise.

This clearly means two things. The first is a restructuring of Petrotrin’s operations so that it is feasible and sustainable with increased levels of production.

The second is managing of national expenditure levels so that any increase in oil prices along with increased production can be used to shore up our reserve positions both in terms of foreign reserves as well as in our Heritage and Stabilisation Fund.

Ian Narine can be contacted via email at [email protected]


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