To continue an unintended series about value, herewith some musings on cost of capital. About 6 months ago I wrote a post (“Financing “Oil 2.0″ will be more expensive. What is the WACC for your next Frac?”) commenting on how Shale 2.0 would be more expensive (and thus probably slower) than Shale 1.0
This theme of changing cost-of-capital – which should now be applied to the whole industry – results from a complex combination of factors. Most of the industry is suffering from a lack of interest in the sector, from public equity (both retail and money managers), as well as private equity. The latter, whilst well poised to take advantage of the downturn, is very selective, and becoming increasingly restricted by the views of their LPs and indeed the stakeholders of those LPs (typically students when the LP is a university endowment, or voters when it is a SWF). Big Oil is fast turning into Big Tobacco in the minds of consumers, albeit with a less obvious cost/benefit analysis. Climate Change, BigOil=Evil Empire, Pollution, and historically very poor returns on investments…. combine into a cliched “perfect storm”.
Whilst the equity story is tough, the real damage is being done in the debt sector. Many of the big name O&G lenders have gone (and here I am talking essentially about the non-US banking market, although the US has had similar trends), and those that remain don’t have anything like the appetite or balance sheet to step up to fill the gap. If we are, in addition, talking about Emerging Market lending; well it is very definitely “risk-off”, and there are rarely any local banks to turn to. Where local banks had started building a presence, irrational exuberance coupled with our wonderfully fickle oil price has resulted in them imploding on excessively overweight O&G loan books and now scary NPL numbers. Don’t hold your breath for a rapid return.
The only “bright spot” is that debt is still stupidly cheap (at least the base-rates). Whilst this is a macro economic theme well beyond the scope of this post (or of me), it does beg the question of how bad things will look if/when base rates start going up again… Maybe interest rate hedges should be on a CFO’s watch list.
So whilst thinking about this I have tried to plot the evolution of the O&G sector financing since I left the industry and went to the dark-side in 2001.Continue reading “The value of an unfunded business plan.”