OCT 20, 2015

Shale oil drillers squeezed by crashing prices and mountainous debt make a tempting target for well-funded private equity and industry investors. “Oil is the biggest investment opportunity in the world,” Stephen Schwarzman, chairman and CEO of top private equity financier Blackstone Group, declared at last winter’s World Economic Forum in Davos, Switzerland.

Yet the shale oil sector has seen no deals of any heft in the eight months since then. Denver-based Whiting Petroleum Corp., the largest producer in North Dakota’s Bakken Shale formation, publicly put itself up for sale in March. No suitors have appeared, even though Whiting’s shares have since fallen another 40 percent, to about $19 as of October 5. (They peaked 13 months ago, at $93.) “Everyone is beginning to ask, ‘Where’s the beef?’” says Deborah Byers, head of the U.S. oil and gas practice for Ernst & Young in Houston.

Some meat may appear on the table before the end of this year as sellers grow more desperate and creditors more restive. But the shale patch’s dispersed ownership, an ever-gloomier outlook for oil prices and some past investment debacles mean that restructuring will likely be drawn out and incremental, lacking the blockbuster acquisitions that might fulfill Schwarzman’s prognostication.

Potential buyers do not lack for dry powder. New York–based Blackstone alone says it has raised $10 billion for energy investments. Rivals like Carlyle Group,KKR & Co. and Warburg Pincus have laid aside as much as $40 billion more. Even these figures are dwarfed by the disposable resources of the oil majors. Exxon Mobil Corp., headquartered in Irving, Texas, has more than $220 billion worth of treasury shares accumulated from buybacks and available as an acquisition currency; San Ramon, California–based Chevron Corp. is sitting on $55 billion in shares and cash.

Meanwhile, the financial noose is set to tighten around struggling operators. October will see a semiannual wave of so-called redeterminations by bank lenders, when they reassess the value of borrowers’ collateral in the ground and could slash credit lines accordingly. Drillers got through this process relatively unscathed in the spring amid expectations that prices would soon rebound.

“Lenders extended and pretended in the first quarter,” says Meagan Nichols, head of hard-asset research at Boston-based investment adviser Cambridge Associates. “There’s a lot of discussion that October will be more stringent.” Equity and junk bond markets, which provided U.S. oil producers with $44 billion in the first half of the year, have largely closed, and hedges arranged before the oil market’s collapse in the second half of 2014 are also increasingly expiring, biting into revenue.

Buyers are looking at the same bearish oil outlooks as bankers, however. The U.S. Energy Information Administration (EIA) downgraded its 2016 forecast this summer to an average of $54 a barrel for U.S. benchmark West Texas Intermediate. That’s perilously close to breakeven for the typical shale oil producer.

“A price of $50 to $60 is close to sustainable in the long term. The big question is if shale producers can keep it going at $40 to $50,” says Michael Lynch, president and director of petroleum markets at Springfield, Massachusetts–based Strategic Energy and Economic Research.

Under current scenarios, shale offers few of the pickings that private equity investors traditionally prefer: companies with reliable cash flows that could take on more debt and be managed more aggressively. The industry is suffering from the aggression it showed and the debt it took on in better days.

The obvious restructuring play in shale is to grab undrilled leases from distressed operators at knock-down prices, then sit on those properties until prices rise again. Unlike the huge fields oil majors exploit over the course of decades, shale wells require relatively low up-front investment and are largely exhausted after a year, making it easier for owners to time production to market conditions.

Many companies can’t stop drilling now because they owe too much. Over the past 12 months, 83 percent of the industry’s cash flow has gone to service debt, according to an EIA report.

But accumulating leases means eventually putting together a corporate structure to exploit them, unfamiliar territory for many private equity firms. “Some of the juicier plays may be too large in scale for private equity players, or the assets need an operator,” Ernst & Young’s Byers says.

The alternative is getting involved in complex and contentious debt restructurings, which are easiest to undertake after bankruptcy. Half a dozen shale oil drillers have filed for Chapter 11 this year, but the biggest names, like Whiting and Oklahoma City–based Chesapeake Energy Corp., whose shares have sunk by two thirds since January 1, are hanging on for the moment.

One more reason buyers may go slow on shale is that private equity and industry investors have already been burned badly in this volatile business. The biggest of the shale oil bankruptcies so far has been that of Tulsa, Oklahoma–based Samson Resources, which filed for relief from $4.2 billion in debt on September 16. Samson’s largest shareholder is New York’s KKR, which led a group of investors shelling out $4 billion for the company in 2011.

Among the oil majors, ExxonMobil spent $41 billion in stock to buy shale-gas producer XTO Energy in June 2010, when benchmark Henry Hub U.S. natural gas prices reached nearly $5 per million BTUs. Today they hover around $2.50. ExxonMobil CEO Rex Tillerson admitted as early as the company’s 2013 shareholders’ meeting that the acquisition of Fort Worth, Texas–based XTO has been “nonaccretive” because “we missed, slightly, the industry’s pent-up capacity.”

Investors with bags of cash will not entirely ignore an unfolding fire sale in an industry that can boom as well as bust. Even as KKR prepared to write off billions on its Samson bet, a group of creditors led by U.S. hedge fund firms Anschutz Investment, Cerberus Capital Management and Silver Point Capital offered to pump $485 million into a restructured company. XTO executives are on the hunt for oil acreage in West Texas’s Permian Basin, using a new investment strategy that involves co-production with existing owners rather than buying assets outright, Bloomberg News reported in September.

With industry conditions set to get worse before they get better, buyers won’t rush, though. “We are saying the same thing as Schwarzman about the opportunity, but with a different time horizon,” Cambridge Associates’ Nichols says.