We have spoken at length on the fundamental balancing act that drives commodity prices – supply and demand. Earlier this month the industry experienced 2 simultaneous black swan events that hit both sides of this equation. First, COVID19 knocked off a major amount of demand for oil (5-6mm bbl/d) and then ROPEC announced that they cannot get along and that they are all going to produce at full bore to protect market share (5-6mm bbl/day). So supply went up and demand went down, leaving a roughly 10-12mm bbl/day surplus overhang of oil on the market, storage is quickly filling up. Prices have collapsed by 60%, with the balance of 2020 pricing in the mid $20 range.
There are very few projects in North America that can economically operate at these levels. This means that for every unhedged barrel of oil operators are losing money. Many of the operators have a break-even in the mid $40s. Here is their major risk, debt burden, their revenue has fallen by 60% but their debt and interest payments have remained the same. So they are now stuck, they cannot increase revenue because they would have to drill more uneconomic wells and borrow more money to drill those wells and due to the nature of their financing, those payments are not going to decrease. This risk is something that the Advanced Royalty Program was designed to avoid, you will never have a payment that you cannot make with an Advanced Royalty Program, since we manage the price risk. Many of these companies are going to go bankrupt, there is little way to avoid it at this point. The can has been kicked down the road since 2014, and things have gotten worse because of it. If you look at the high yield bond market in the energy industry, yields are currently 20%+-, indicating the fact that there is a high chance of bankruptcy.
The bright side is that associated gas is dropping, since few new oil wells are being drilled. This gives some support to the pure natural gas drillers, but demand has fallen significantly, offsetting this. They are in the same boat.
If you are an operator or mineral owner that has production and needs capital, ARC can be a great solution. We are still underwriting loans and financing and can help you avoid the dire situation that many operators with reserve based loans and credit facilities are in.