The sharp decline in oil prices at the beginning of 2020 amidst the COVID-19 pandemic has led to increased speculation about the state of the economy and potential impacts on the financial health of public companies. The collapse of oil prices has historically been associated with multiple impacts on companies’ financial statements, including increased risk of asset impairments, cash flow/profitability concerns, and debt restructuring issues. In some dire circumstances, a failing company may file for bankruptcy.
Oil prices have plummeted due to diminished demand for gasoline, jet fuel, and diesel, and on April 20, 2020, West Texas Intermediate crude oil price hit a low of -$40.32 per barrel. This is an unprecedented low price due to oversupply during an unprecedented pandemic that changed how many people lived their lives.
Audit Analytics previously analyzed the effects of oil prices on bankruptcies for SEC-registered public companies and found that in the years following a steep decline in oil prices, there was an increase in the number of bankruptcies in the oil and gas industry (SEC registrants with NAICS Codes 211 and 213 – Oil & Gas Extraction and Support Activities for Mining).
Considering the unusual circumstances currently surrounding oil prices, in this analysis Audit Analytics explores the historic trends of the amount of bankruptcies in relation to trends in oil prices.
According to the U.S. Energy Information Administration (EIA), West Texas Intermediate (WTI) oil prices are expected to average $35.14 per barrel through 2020.This is significant, as annual averages of WTI oil prices per barrel have not fallen below $43 since at least 2006.1 The lowest annual average since 2006 was recorded in 2016, at $43.6 per barrel; that year also saw a record number of oil & gas companies file for bankruptcy.
As can be seen in the graph above, historically, the years following sharp declines in oil prices have higher numbers of bankruptcies in the oil industry, and in general. Considering the current annual average price of oil (around $36.5 as of June 2020) is the lowest it has been since at least 2006, it would not be surprising to see an increase in the number of bankruptcies in 2020 and 2021.
In the first six months of 2020, eight companies in the oil and gas industry have filed for bankruptcy, compared to ten for the entire 2019 year.
The circumstances surrounding the bankruptcy protection filings is different for each company, but common themes cited in their bankruptcy filings include the declining commodity price, increased oil supply due to the failure of foreign countries to reach an agreement on oil production quotas, and debt repayment obligations.
In addition to filing for bankruptcy protection, the eight oil and gas companies have experienced other adverse events leading up to the bankruptcy. For example, 50% of those companies received a going concern modification in their most recent annual audit opinions, indicating substantial doubt about the company’s ability to continue as a going concern for the next 12 months.
Whiting Petroleum Corp. [WLL] did not receive a going concern modification, but did record a non-cash impairment charge of $3.7 billion in the first quarter of 2020 to reduce the carrying value of proved oil and gas properties. This charge was partially due to the reduction in anticipated future cash flows resulting from the falling cost of oil. To offset this charge and manage reduced cash flows, the Company has decreased overall spending and focused drilling efforts only on projects with the highest rate of return.
Per the latest short term energy outlook (STEO) by EIA, oil prices are expected to rise to $43.88 in 2021, reflecting an anticipated decline in global oil inventories for the second half of 2020. The projected 2021 oil price per barrel is comparable to 2016; as mentioned previously, since 2006, the year 2016 saw a record number of companies in the oil and gas industry file for bankruptcy, and had the fifth most bankruptcies across all industries in the last 14 years. This suggests that the number of bankruptcies in 2020, and perhaps 2021, will be higher than in recent years.
While the first six months of 2020 saw some oil companies file for bankruptcy, US government intervention may have prevented some companies from declaring bankruptcy – a result of a CARES Act tax incentive that allows prior year earnings to offset current losses. If oil prices remain low through the rest of the year and no further intervention is provided to assist struggling oil and gas companies, the second half of 2020 will likely see an increase in the number of bankruptcy filings for the industry.
The exact impact of oil prices on bankruptcies for 2020 will be difficult to quantify. The COVID-19 pandemic has resulted in widespread economic disruption, stemming from more than simply the declining price of oil. To get a sense of the trend in amount of bankruptcies that could be expected in 2020, Audit Analytics looked at historical trends in bankruptcy filings for all industries, by month.
In looking at the past 14 years, only 5 years have seen more than 50% of bankruptcies filed between January and June in each respective year, while 9 years saw 50% or more of bankruptcies filed in the second half of the year, from July through December, indicating that more companies file for Chapters 7, 11, or 15 bankruptcies more often in the second half of the year.
Most years only deviated within +/- 10% from the 50% mark between the first and second half of the year. Though, the notable exception is 2008, the year of the recession, which saw 60% of bankruptcies filed in the second half of the year.
In the first six months of 2020, through June 30, 2020, 48 SEC registrants have filed for bankruptcy protection, which constitutes 96% of 2019’s total bankruptcy filings and surpasses the total for 2018.
Based on this general trending in the first six months of 2020, the volume of bankruptcies in 2020 is on pace to surpass the number of bankruptcies filed in every year since 2016.
The impact of low oil prices, combined with the ancillary impacts from the unprecedented COVID-19 pandemic, could create untenable conditions for many companies throughout at least 2020, and may continue into 2021 if oil remains at this unparalleled low price and the pandemic continues to cause global disruption.
For more information about Audit Analytics or this analysis, please contact us.
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1. WTI Crude Oil historical prices obtained from:
U.S. Energy Information Administration, Crude Oil Prices: West Texas Intermediate (WTI) – Cushing, Oklahoma [DCOILWTICO], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DCOILWTICO, June 14, 2020. ↩