Here’s a fun article. I expected this sometime last year, as it shows the largest oil sector firms understand what must be done.

In order to regain stability of the oil market, production needs to be brought in line with consumption. That is not rocket science. What is considerably more difficult is how that process is permitted to play out.

It’s the overpopulated island problem. Two men are stranded on an island with just enough food for one to survive. How many men survive?

No men survive. They both eat just enough food to ensure they both die, fighting each other the whole way. That’s just instincts.

Baker Hughes and Schlumberger are two of the biggest players in the services space. And they’re old and well connected and staffed by pretty smart people. I’m comforted that someone is finally forcing the weakest hands to wrap up their deaths, as in the long term this is going to minimize the damage to the US energy sector.

Hopefully the more stable services firms can come together, pick the US supply that needs to be idled, and shut it down. Waiting for these zombie oil companies to keel over themselves is growing tiresome.

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BAS just reported utilization numbers for October, and nestled in the release was this gem:

Drilling rig days for the month were 50 producing a rig utilization of 13%, compared to 27% and 88% in September 2015 and October 2014, respectively.

In the BAS earnings call, CEO Patterson gave advanced notice that this was happening. Basically, as companies hit their 2015 budgets in this awful environment, managers are just idling drilling fleets rather than bother asking for more. We should start to see drilling collapse to 0% over the last month and a half of the year.

This should be an almost industry wide phenomenon. Then, we wait and see if they come back online in January.

Of course oil prices are now screaming to $40, testing every nerve I possess. This is the most trying market I have ever had the bad luck of being caught in. Even in 2008 I had the good sense to get out while I still could.

Yet here I am, in the most milquetoast of economic situations, watching billion dollar companies being sliced into quarters for no reason other than some foreign devils decided they’d rather gamble away their very existence.

Good grief.

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She moves through the darkness, one leg in front of the other, silently across the floor. The cool air wafts around her legs as she begins to climb the stairs. One, two, three… the stone makes hardly a sound; the clattering of footsteps cannot be heard.

The wood does not creak as she steps onto the landing. A light at the end of the hall peaks out of a doorway. She passes through it.

The foot rests in front of her, beneath the desk. Softly, she passes next to it, at the last moment letting her body rest against the flesh, rubbing slowly.

She purrs – a deep loud sound – then soundlessly arrives in Cain’s lap, flexing her claws one of the next before letting his hand stroke her head and long body.

I pass my fingertips through her long hair, ending by twirling the lynx shaped tufts with my forefinger and thumb. Then I turn back to what I was reading.

4:26 pm Hi-Crush Partners misses by $0.04, reports revs in-line; announces temporary distribution suspension (HCLP) :

Reports Q3 (Sep) earnings of $0.15 per share, excluding non-recurring items, $0.04 worse than the Capital IQ Consensus of $0.19; revenues fell 20.3% year/year to $81.5 mln vs the $80.9 mln Capital IQ Consensus.
The Partnership reiterated the guidance for capital expenditures in the range of $50-$55 million for 2015 of which $48 million was spent in the first nine months of the year.
Capital expenditures for 2016 are expected to be in the range of $15-$25 million for the continued development of new terminal facilities.
Since August 1, 2015, Hi-Crush has reduced operational and administrative staffing levels by ~16%, including the most recent reductions at the Augusta facility.

Distribution Temporarily Suspended

The Partnership announced a temporary suspension of its quarterly distribution due to challenging market conditions.
Co paid distributions of $2.40 per unit on all common and subordinated units for 2014, $0.675 per unit for the first quarter 2015, and $0.475 per unit for the second quarter 2015.

I had expected something like this, particularly after EMES withdrew guidance. While I had hoped they would only reduce to a more normal percentage, suspending the entire distribution until fairer weather is perfectly acceptable. SLCA and EMES are going to do the same.

The most recent HCLP filing is out and it shows the story: accounts receivables have declined by 35% as business dries up. But the business is hardly over leveraged with Debt/Equity still holding below 2X. Cash levels increased by over 8% and now with the distribution halt, they are staking out the long winter.

HCLP has moved to shrink the business aggressively, cutting staff by 16%. Admittedly this is nothing like one of the services companies or some of the smaller oil drillers. But then again…they don’t have that kind of problem, now do they?

HCLP took a loss this quarter of ($0.49) a share, which was entirely driven by one time write downs. The company is in a similar (though less dire) process as other companies in this industry, cutting dead weight operations and consolidating around profit centers. They are also writing down and taking losses where applicable. In this case, HCLP wrote down some of their long term supply contracts (presumably because the customers aren’t going to live long enough to fill them).

Cash from HCLP’s operations only declined by about 11%. HCLP already spent about $48 million this year on investments in equipment and facilities, but they are looking to pair that back next year to $15-25 million.

Without the distribution and with the lower capital expenditures, HCLP will have expenses of inside $30 million per year. Cash flow is $67 million which even if we continue to impair, should more than cover the costs of doing business.

If HCLP was forced to go the BAS route and write off all goodwill and intangible asset value, they’d still have about $2 per share of equity to work with. That leaves another $69 million of equity as a buffer.

This line in the filing does concern me:

Under the terms of the Revolving Credit Agreement, our leverage ratio (total debt to trailing four quarter EBITDA) may not exceed 3.50. While our leverage ratio as of September 30, 2015, is below this threshold, if current market conditions persist, our leverage ratio will likely exceed this threshold during 2016, which could result in a breach of covenant event and an event of default under the Revolving Credit Agreement. If such a default were to occur, and resulted in a cross default of the Term Loan Credit Agreement, all of our outstanding debt obligations could be accelerated. The Partnership is currently in discussions with the lenders to amend the Revolving Credit Agreement to, among other things, waive the leverage and other compliance ratios. The Partnership makes no assurance that an amendment will be obtained.

So the question becomes, how willing are lenders to play ball? Promise of money is better than no money, no? It’s not as if bankers could run HCLP better than HCLP is. But these things always get messy.

In principle, there’s plenty of time here to ride out the storm. But we need oil markets to stabilize. BAS’ CEO Patterson says he sees signs of oil production going offline and was talking about operations idling after Thanksgiving. It sounds like companies have spent their budget this year and aren’t going to bother asking for more money.

Patterson also said he’s seen competition spike in his local markets, with thirty or more competitors entering to submit bids. In his anecdote, he said about twenty of them are left now.

Although it may not feel like it, the weak are being driven out. The industry is getting their cost to drop and they are learning to compete with the cheaper oil levels. This hurts but the survivors will probably be built to last. Provided, of course, that you are a survivor.

Budgets are being frozen in December. The oil producers are going to take a little recess. We’ll see what oil prices do in response.

Then things will get started again in January.

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On Thursday evening, EMES withdrew distribution guidance. On Friday, shareholders were treated to a one day ~30% drawdown. HCLP and SLCA fell ~10% each, in sympathy pains. The whole sector was flayed.

The weekend has offered no respite, as HCLP and SLCA are both down another ~8% and EMES is off another ~12% on Monday.

Here’s a preview of what’s to come.

All three are going to slash their distributions. Of course they are…they’re yielding like 20% and it’s an industry freeze. They’ll walk it back to ~10% yield, those of us who’ve been here from the start will be back to what we were making two or three years ago, and all three companies will be better off for it.

Now things are getting out of hand. I cannot speak for SLCA or EMES, because I don’t own either. I never wanted to own either. But I do speak for HCLP when I say a great company is going for peanuts.

Now, I am not adding to my position. I restructured back in December, I ended up with about 1/2 my account in cash (after factoring in losses into this year) and it has been single handedly responsible for keeping me alive. My losses have been horrific; without that restructuring they would have ended me (and that is not an exaggeration).

So I’m not buying until the recovery is already well underway. If I had been so fortunate to be outside this fire, looking in, then I would be nibbling incrementally, every couple of weeks. But that is not a luxury I personally get to enjoy.

So far for the year, I’m down about 15% – that’s about 40% peak to trough if I’m counting from when this process all started a little over 12 months ago. I guess if I’m looking big picture, I’m fortunate that’s all that’s happened. There are people out there who have lost 70% because of this oil catastrophe.

For the moment, I am more than content to sit on lots of cash and wait this thing out. I’ve dug into my companies and am very confident they’re going to make it. But not everyone gets to say that.

There are vast expanses of the oil and gas industry that are about to be swallowed whole. We have a backwater culture that still crucifies people to thank for this.

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We’re still in the midst of watching the oil industry unravel in spectacular fashion. I do not feel comfortable even uttering the word “bottom”, not even in jest, for the fear the entire structure would unwind and usher in $10 oil for two decades.

We need more expensive oil. I know you do not want to hear that; why just a few weeks ago I saw a long dormant Hummer H3 roaming the tundra planes of southeast Michigan. A once formidable species, these vehicles could once be seen all across the North American continent.

Their reemergence was a startling sign. Gasoline has gotten cheap.

It is comforting to think of these lower input costs as an unchallenged blessing to America. It is more complicated than that, I am afraid.

High oil prices have been one of very few elements that has actually helped foster stability in third world countries. Watching the recent turmoil and wars, it is easy to forget just how unnaturally peaceful the most recent decades have been in the grand scheme of things. Oil money has been used to weave the social fabric in these places and if oil prices stay low for a sustained period, we are going to see much more egregious cases of foreign sovereign collapse.

Oil prices have also driven the US recovery. The shale revolution was named thusly for a reason; job growth in the US would not have been possible without the advances in shale oil. This is a major pillar of the US recovery and without it our economy is going to suffer. High input costs were a minor inconvenience that came with job growth.

And of course there is the euro. The euro may just be the cause of the oil collapse in and of itself. I cannot say for certain yet, but I am suspicious. The euro and dollar are now almost at parity and this has crippled US exporters. If our own markets are suddenly sloshing around with oil to spare, it is because we are suddenly priced out of foreign markets. This is a precarious barrier…how cheap would oil need to be in this country to enable exporters to compete against euro/dollar parity? The dollar is going to isolate our business and tank us if we let this continue.

We need to start taking steps to regain stability. Bernanke would have never let this happen. Yellen is pushing for normalization of policy and this is not a bad thing. But they are far too comfortable watching a currency move like this happen with our probably largest trade group. We need a weaker dollar and we need more expensive oil and we need it now.

Now, because oil is so cheap, struggling shale producers are clocking overtime to meet payments. This is the exact opposite of what the oil markets need to find a bottom – a glut of even more oil.

In addition to addressing currency and demand issues, we really need a JP Morgan figure to emerge and start brokering some M&A moves that stitch up the supply side. Oil markets are leaking supply uncontrollably and this is going to cause extensive damage if not treated like the dire risk that it is.

The weak hands need to be either bought out or flushed or secured with long term financing. If we can’t shut some of these wells off, we’re going to have irreparable damage on our hands.

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I am getting constructive on oil markets, and starting to feel more comfortable with my BAS, VOC and HCLP positions. I may just edge in a little further, in another month or so.

I understand how dark prospects for oil are right now; we have numerous estimates calling for the total dismantling of oil, sending it into the $20’s, and suddenly those forecasts aren’t feeling quite so fanciful. It’s the fear creeping up in people.

But how many of these forecasts existed before last October? Tell me that, will you? Back in July, it was only a matter of how many $10’s we could stack on top of the $100 mark. Nobody I know was seriously calling for sub-$40 oil. Even those of us who were expecting a pullback had the $70-90 range as a guide. Which is why almost everybody long got smoked. Even scaling a position back to half the size wasn’t enough to escape this (trust me I know).

Which leads me to think a lot of these “experts” talking up ultra cheap crude oil are just trolling the public. Goldman Sachs has a pretty horrible record of forecasting commodities, actually. That’s not how commodity storage facilities work – there you have cheap cost to store and opportunistic offerings and purchases. You also have a futures trading desk which you can tie into to cooperate with. But you still don’t know what’s going to actually happen. You just roll with it and make money as you can.

Names like BAS are chopping 8% every other which way. But they are working a floor in, and steadily, slowly, offering higher prices.

And what about the demand for crude globally? Yes there was a (not really that) significant excess supply gap, which is growing. But that gap existed with $100 crude oil and well development pricing in $100 crude oil. We are seeing just massive layoffs as the industry reacts to new facts on the ground. So future supply is being taken offline.

And to boot, oil is cheap now. So cheap.

Look at industrial output in the Eurozone; one part oil prices, one part a cheap currency. Is that killing the US? Nope, we seem to be absorbing the currency strength but still happily putting along. Cheap oil lifts all boats. I was very concerned that oil prices would make a serious headwind to the US – and certainly on some level it is, gross – but net jobs are working out fine as any complications from the Dakota’s are being more than offset.

Currency games are fun, but net economic growth is all that really matters at the end of the day. If a few thousand losses in one spot beget a few thousand gains in another, then activity will continue apace and crude demand will keep growing. You’re only really in trouble if you start getting net losses.

I think the oil market got way ahead of itself as unabashed speculators got their comeuppance. This is drawing to a close and I wouldn’t be surprised if oil abruptly rediscovers that $70-90 range we all sort of guessed was a fair price. I would not count on crude oil hanging out at levels from the 20th century, because that’s just not how extraction costs have trended.

And ultimately, no matter what crude oil does, I think there are going to be limits to how much devastation we see in oil companies. It doesn’t take much to swing the oil market back into balance; the imbalance is really not that significant. If oil sustains these prices, it will be because it is profitable for enough US shale companies to do so. If US shale cripples, you are going to see way more than just US shale cripple. Which is sort of a Catch 22.

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