Oil Price Wars Could Lead to More Lease Defaults for Oil and Gas Tenants

Oil Price Wars Could Lead to More Lease Defaults for Oil and Gas Tenants

Over the past week, two global energy powerhouses, Russia and Saudi Arabia, escalated ongoing oil price tensions by increasing production and immediately driving down oil prices. The Saudis agreed to increase production to 13 million barrels of oil per day (bpd) as of March 11, 2020, while Russia signaled that it would increase production by 200 to 300 thousand bpd to roughly 11.5 million bpd. The two powers are contravening an agreement between OPEC and Russia, and the net effect has brought the price of West Texas Intermediate (WTI) below $30 per barrel as of the publication of this post (Brent crude was just above $32 per barrel).

We’ve seen this movie before with different characters. Back in 2014, Saudi Arabia unilaterally increased production dramatically, bringing oil prices below $50 per barrel from their highs of around $100. Price volatility has always been a key risk for the oil business, which includes on and offshore exploration and production companies, midstream companies, oilfield services companies. Russia and Saudi Arabia appear to be taking aim at one another, but U.S. oil and natural gas companies could be the first victims of this price war.

Potential Impact on U.S. Oil and Natural Gas Companies

U.S. oil and natural gas companies rely on a certain price for oil and natural gas in order to pull it out of the ground at a profit. U.S. operators generally have higher extraction costs than their Russian and Saudi peers, while simultaneously being burdened with significant debt in order to fund the capital investment needed to extract the oil and natural gas. Each U.S. exploration and production company has a different price tolerance based on the unique nature of the deposits they extract from, but in general, prices need to remain above $35 in order to break even. The elevated costs of extraction coupled with the high debt burden could lead to potential defaults across the industry.

What Could This Mean for the Real Estate Sector

Back in 2014 and early 2015, we began reviewing rent relief requests from distressed oil and gas tenants. Many of them lacked sufficient balance sheet flexibility and access to capital to fund operations through the oil price trough. If the price war between Russia and Saudi Arabia continues for an extended period of time, U.S. companies could begin seeking ways to reduce operating costs. Obvious first steps include trimming variable costs such as production and staff; but longer term, they may need to address fixed costs like rent and interest burdens. The weakest companies may need to declare bankruptcy, which could lead them to vacate office space. For some of the healthier companies, it may be worth it for landlords to consider rent relief.

Reach out to TRA to see how we can help you understand your exposure and ways identify and evaluate risks associated with the oil and gas sector.