January 21, 2015

Slaying The Debt Monster: Finances Of 10 Oil And Gas Companies In Colorado

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Understanding how debt plays into the web of a company's finances was a beast - nay, a monster. We faced the Debt Monster with only 10-Ks to protect us.

Jordan Wirfs-Brock/Inside Energy

Understanding how debt plays into the web of a company's finances was a beast - nay, a monster. We faced the Debt Monster with only 10-Ks to protect us.

Oil prices have dropped fast enough and long enough – 57 percent since June 2014 – that the initial price dip has become a veritable plunge, inspiring analysts and journalists to scrutinize the financial stability of oil and gas companies and the banks that fund them. Much of this scrutiny – including Inside Energy’s coverage – has been focused on the companies’ mounting debt loads.

Why does this matter? The health of the oil and gas industry, and of the banking system that has bankrolled it, are a key part of U.S. economic recovery. The more we learn about energy financing, the more we realize debt is just the beginning of the story. So we wanted to know:

To monitor the financial health of oil and gas companies, what else besides debt should we keep an eye on?

Understanding how debt plays into the web of a company's finances was a beast - nay, a monster. We faced the Debt Monster with only 10-Ks to protect us.

Jordan Wirfs-Brock / Inside Energy

Understanding how debt plays into the web of a company’s finances was a beast – nay, a monster. We faced the Debt Monster with only 10-Ks to protect us.

In answering this question we learned two very important things. First, the financing and operations of a company are a unique and intricate web. Therefore, it’s difficult to come up with a single, comprehensive measure of financial health that lends itself cleanly to cross-company comparisons. Second, journalists are not accountants: Our goal with this investigation is to illustrate and decode several important financial indicators for some of the most prominent oil and gas companies operating in Colorado.

To do this, Inside Energy examined the financial statements of ten oil and gas companies operating in Colorado: nine of the largest publicly-owned operators based on oil production volume, as well as one other company, Linn Energy. Why Linn? Analysts at Debtwire, in an email teasing their Distressed Watchlist for December 2014, identified it as potentially financially unstable. For operators that are the Colorado arm of a larger national or international company, we analyzed the financial statements of the parent company.

Choosing indicators to look at beyond debt
We aren’t the only ones combing through oil and gas company finances. Banks – who finance debt and stand to gain or lose money depending on whether that debt is paid back – are looking too. Loan agreements often contain stipulations, called debt covenants, that companies must meet to demonstrate their financial stability. The requirements are negotiated within the context of the current economic climate, and vary from bank to bank and loan to loan. We gathered data on three measures common in debt covenants:

Current Ratio

  • What it is: Current assets divided by current liabilities.
  • What is shows: The ability to pay off immediate financial obligations. The higher the ratio, the more easily the company can pay.
  • Simplified analogy: The value of your checking account this month added to anything you could sell for cash this month, compared to all of the monthly bills you must pay.

Debt-Equity Ratio

  • What it is: Total liabilities divided by total shareholders’ equity.
  • What is shows: How leveraged a company is – that is, how much of its financing comes from debt rather than from shareholders. The higher the ratio, the more the company relies on debt to finance its operations. In general, a higher ratio is less concerning for a large and well-established company than it is for a small or new company.

Interest Coverage Ratio

  • What it is: Operating income divided by interest expenses.
  • What it shows: How burdened a company is by the costs of borrowing. The higher the ratio, the less we should worry about its ability to pay the interest on its debt.
  • Simplified analogy: Take the amount of money leftover after you pay rent, utilities, and groceries. Divide that by the amount of interest that you pay on your loans and credit cards. The more disposable income you have compared to the amount of interest you pay, the better your financial position overall.

We also looked at two other metrics that investors often watch:


  • What it is: Earnings before interest, taxes, depreciation and amortization.
  • What it shows: A rough leveler used for comparison of companies’ profitability, focusing on operations and minimizing financing decisions and accounting practices. In general, bigger is better, but should be considered in conjunction with other measures, such as cash flow.

Cash Flow from Operating Activities

  • What it is: How much money the company generated in the reporting period as a result of running their business.
  • What it shows: The company’s ability to earn money, rather than just obtain money through financing their operations with investor money or loans.
  • Simplified analogy: The amount of money you make as a result of being employed.

We gathered these indicators for 2010 through 2013 from the annual financial statements that companies file with the U.S. Securities and Exchange Commission. (If you’re brave enough to dig into the statements yourself, you might find this how-to from the SEC useful). It was a complicated, time-consuming, brain-numbing process that involved digging, wrangling and financial detective work. (But heck, as much as we were cursing our boss for giving us this assignment, we got paid to do it). We checked, double-checked, and sometimes even triple-checked the data. You can view the full results here.

An overview of the ten companies
The ten companies that we investigated and any potential red flags are summarized in the table below. Each indicator has a generally accepted threshold; if the ratio ticks above or below that threshold, potential lenders and investors see a red flag.

Debt burden growing across the board
We began our analysis by looking at how the total debt of each company changed over time. With the exception of Encana, every company reported an increase in debt. Some increases were small, but some were sizable, like in the cases of Linn Energy and Whiting Petroleum. Three of the companies we looked at –  Nighthawk, Synergy and WPX Energy – had no debt in 2010. At the end of 2013, all companies reported some amount of debt.

Get the data: CSV | XLS | Google Sheets | Source and notes: Github
The fact that a company or person takes on debt isn’t necessarily bad news. It could be because the company is expanding, or strategically aiming to take advantage of certain tax benefits. For comparison, if you take out a student loan to get a college degree, or take out a mortgage to buy a house, that could improve your financial stability in the long term. In order to invest in those long-term gains, you need to take on debt in the meantime. The same applies to companies.

Figuring out whether increasing debt is problematic requires a deep understanding of what else is happening in a company. The other indicators we chose – current ratio, debt-equity ratio, interest-coverage ratio, EBITDA and cash flow from operations – serve as a launching point for that deeper analysis. To thoroughly judge the financial health of a company, even more would have to be taken into consideration.

Current ratio raises red flags for several companies
The current ratio measures the ability of a company to pay off its immediate financial obligations. The higher the ratio, the more easily the company can pay. At the end of 2013, two companies, Linn Energy and WPX Energy, had current ratios that were below the red-flag threshold. Three other companies – Whiting Petroleum, Bonanza Creek Energy and PDC Energy – had current ratios less than one at some point between 2010 and 2013 that have since rebounded.


Debt-equity ratio climbing but still in a safe range
The debt-equity ratio measures how leveraged a company is – that is, how much of its financing comes from debt rather than from shareholders. The higher the ratio, the more the company relies on debt to finance its operations. Several companies– Encana, Linn, Bonanza Creek, WPX Energy– had increasing debt-equity ratios over the past few years. None of the debt-equity ratios were alarmingly high, though we will keep an eye on Encana’s.


Interest coverage ratio raises red flags for several companies
The interest coverage ratio measures how burdened a company is by the costs of borrowing. The higher the ratio, the less we should worry about its ability to pay the interest on its debt. Several companies – PDC Energy, Linn, Nighthawk and WPX Energy – ended 2013 with interest-coverage ratios below 2.5, which is a potential warning sign.


EBITDA and cash flow from operations
Both of these indicators give insight into the operational performance of a company – in this case, operations are oil and gas production – but in slightly different ways. Investors need to know whether a company is actually generating money from its business, so they look at the size, timing and trends of its cash flow from operations. EBITDA adds another dimension by giving a quick read on profitability: It’s a rough way to evaluate how effective a company’s overall decisions are, including the cash flow piece of the puzzle.

Unlike the other indicators, which are ratios, EBITDA and cash flow from operations are absolute dollar measures that are difficult to compare across companies of different sizes. What is important here is the pattern for each company over time: Is EBITDA going up, going down, or staying steady? Is cash flow positive or negative? In general, a higher debt load is concerning when EBITDA and cash flow are volatile and even more so if they are decreasing.

Some companies – Bonanza Creek, Whiting Petroleum, and Synergy– had steadily increasing EBITDA and cash flow from operations, which is a good sign that their operations are bringing in money. WPX Energy, however, saw its EBITDA drop to a negative value and its cash from operations dip 40 percent.


What we found: Diversity among companies’ financial health
While debt increased across the board for these ten companies, the extent to which that should alarm us varies. Three companies – Noble Energy, Synergy Resources, and Whiting Petroleum – took out more debt but also enjoyed improvements in profitability and cash flow from operations, and are clearly not overburdened by the size of their debt.

Others, however, are in worse shape. PDC Energy and WPX Energy not only increased their debt, but also saw both cash flow from operations and earnings decrease from 2010 to 2013. This means that their debt load is now more burdensome. Furthermore, both companies have alarmingly low interest coverage ratios, which may signal that they’ve maxed out on their ability to access more debt financing. Since it’s too early to see the full effects of the oil price plunge on financial statements, we suspect that these companies were not in great shape even before prices started to slide.

There are two companies – Encana and Linn – for which we’re eagerly awaiting the latest financials, because any negative impact from lower oil prices could potentially tip the scale on their overall health. Linn Energy still has positive cash flow and EBITDA, but they’re walking the line with their debt load. Although Encana was the only company whose debt slightly decreased, its debt-to-equity ratio more than doubled, and its EBITDA decreased by more than half – generally, pretty bad signs.

What’s clear here is that two companies can be moving in the same direction on one indicator, like debt, but in different directions on another. Which means that looking at any one of these indicators in a vacuum doesn’t say much. The indicators we chose in addition to debt certainly help to flesh out the picture; but to make a thorough analysis of how an oil company will weather the oil price plunge, one would need to dig even deeper.

Looking ahead: The full fallout is yet to come
We’ve already seen some fallout from the 2014 oil price slide. One small producer in Texas recently filed for bankruptcy. Layoffs have been announced at companies around the country, which Forbes estimates total at least 15,000 nationwide. While production is still going strong, the wind seems to have been taken out of the sails of the U.S. oil and gas boom. We expect that over the next year or even many years we will continue to see the effects of the 2014 oil price slide on companies: mergers, buyouts and possibly bankruptcies if companies are unable to pay back debt.

Inside Energy is just beginning to peel the oil and gas finances onion – an onion with many, many layers. We plan to keep following these 10 companies as they release financials for 2014 and the first quarter of 2015. What would you like us to investigate next? Leave us a comment below with your suggestions or questions.

What’s Next?

  • Javier Valadez Jr.

    Great article! Look forward to learn more about the financing on the oil boom. What I would like to know is, with all the wind being knock out of this little bubble, what does an oil company do to keep growing and keep production steady at this new level of oil prices. What do they cut out first, and how do they remanage?

    • Dan Boyce

      Hey Javier, thank you kindly for the feedback and the suggestions. We will definitely keep your thoughts in mind as we move forward with this topic.

      Oh and hey, make sure to follow us on twitter and Facebook and stuff! (@insideenergynow)

    • amberrivera14

      Hi Javier – thanks for reading, and glad you enjoyed it.

      Every company is unique and its management may use different levers, to different degrees, to weather tough times. Some companies have taken on more debt in order to make investments in production. Other companies might focus on making their operations leaner in order to cut costs so that production can at least hold steady (could mean layoffs, negotiating lower rates with contractors, or pushing pause on developments).

      If you’re interested in the inner workings of these publicly-traded companies, you can join their quarterly investor calls. They are required by law to announce when the calls will be. Here’s an example of an upcoming call for WPX Energy: http://www.wpxenergy.com/news-and-media/press-releases/pressrelease.aspx?id=e3d083db-13f7-4b52-b409-49659f2557b0

    • Jordan Wirfs-Brock

      Hi Javier,

      This is Jordan Wirfs-Brock from Inside Energy, one of the authors of this post. I know it’s been a while since you wrote, but a few things that might be of interest:

      Our North Dakota, Emily Guerin, has been following the break even prices for oil, by county, in the Bakken. Here’s a story that looks at how the impact of falling oil prices veries: http://insideenergy.org/2014/10/17/where-do-falling-oil-prices-hurt-most/. And here’s a great explanation of where the break even prices come from in the first place: http://insideenergy.org/2014/10/16/why-80barrel-isnt-the-number-north-dakota-should-care-about/

      Thanks for reading, and let us know if you have any further questions.

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  • Kirk Spano

    Updated 2016 Energy Report – http://fundamentaltrends.com/research