Junk Debt Pays For Fracking

Bloomberg:

The U.S. drive for energy independence is backed by a surge in junk-rated borrowing that’s been as vital as the technological breakthroughs that enabled the drilling spree. While the high-yield debt market has doubled in size since the end of 2004, the amount issued by exploration and production companies has grown nine-fold, according to Barclays Plc. That’s what keeps the shale revolution going even as companies spend money faster than they make it.
“There’s a lot of Kool-Aid that’s being drunk now by investors,” Tim Gramatovich, who helps manage more than $800 million as chief investment officer of Santa Barbara, California-based Peritus Asset Management LLC. “People lose their discipline. They stop doing the math. They stop doing the accounting. They’re just dreaming the dream, and that’s what’s happening with the shale boom.”
Companies with a lot of debt relative to earnings use junk bonds to raise cash. Investors get higher returns because of the increased odds of not getting paid back. The debt is in demand because the Federal Reserve has heldinterest rates near zero for more than five years, shrinking returns on safer bets. The popularity has pushed down borrowing costs for companies trying to unlock oil and natural gas trapped in deep underground layers of rock like the Bakken shale in North Dakota or the Eagle Ford in Texas....
Of the 97 energy exploration and production companies rated by S&P, 75 are below investment grade, according to the credit-rating company. The average yield for energy exploration and production companies rated junk has declined to 5.4 percent from 8.1 percent at the end of 2009, compared with a drop to 5.21 percent from 9.06 percent for all companies rated below investment grade, according to Barclays.
Cheap debt, along with advances in horizontal drilling and hydraulic fracturing, or fracking, have propelled U.S. oil output to a 26-year high. Last year, the country produced 87 percent of its own energy, putting it closer to independence from foreign sources than it has been since 1985, according to the Energy Information Administration.
It’s an expensive boom. About $156 billion will be spent on exploration and production in the U.S. this year, according to a December report by Barclays analysts led by James West. That’s 8.5 percent more than last year and outpaces this year’s expected 6.1 percent growth in global expenditures, the analysts said.

It is never good to see somebody mention Kool-Aid being drunk.  This is a scheme that will come crashing down.  It will get more expensive to drill less-productive wells, and prices are going to be extremely sensitive to over- or underproduction.  Companies are borrowing to drill, and using proceeds to pay off the creditors before borrowing to drill again.  With the rapid well depletions, there just isn't a lot of cushion for some low-production wells.  Things will get ugly in the shale plays in the next couple of years. I hope the optimists don't put too much of their money on the line, or they might be less rosy about things soon.