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Upstream Companies’ Leverage: Why It’s a Concern

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High leverage

Many of the smaller upstream companies (XOP) have become highly leveraged. This increases the possibility of a default or bankruptcy. Linn Energy (LINE) made a filing on March 2. It said that there would be a delay in the company’s 10K filing for 2015. The company’s net debt was 4.4x its equity at the end of 3Q15.

In the filing, Linn Energy said that “Uncertainty associated with the company’s ability to meet its obligations as they become due raises substantial doubt about its ability to continue as a going concern.”

Laredo Petroleum’s (LPI) net debt was 10.5x its equity at the end of 2015. The above graph shows the net debt-to-equity ratios of Laredo Petroleum, Linn Energy, Chesapeake Energy (CHK), Carrizo Oil & Gas (CRZO), and Southwestern Energy (SWN).

Ultra Petroleum (UPL) had a shareholder deficit—negative equity value—of $3 billion at the end of 2015. This resulted in a negative debt-to-equity ratio.

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Net debt-to-EBITDA

Laredo Petroleum, Chesapeake Energy, and Southwestern Energy Company had negative EBITDA (earnings before interest, tax, depreciation, and amortization) for 2015. So, their net debt-to-EBITDA and EBITDA-to-interest expense ratios are negative or meaningless for the period. Such a situation raises grave concerns about the companies’ ability to meet obligations on a sustained basis.

Last month, Standard & Poor’s downgraded the junk ratings on 25 oil and gas producers including Breitburn Energy Partners (BBEP), Memorial Production Partners (MEMP), and EV Energy Partners (EVEP). According to a report by Deloitte, up to one-third of publicly traded oil companies worldwide risk going bankrupt in 2016.

The midstream sector will likely face heat from these potential bankruptcies.

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