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Speaker 1: Hello, and welcome to The Credit Edge, a weekly markets podcast.

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Speaker 1: My name is James Crombie. I'm a senior editor at Bloomberg.

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Speaker 1: This week, we're very pleased to have back on the

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Speaker 1: show Alice Wong, who covers credit markets for Bloomberg News

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Speaker 1: in Hong Kong. How are you, Alice, Hi.

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Speaker 2: Am doing well. Thank you, Sean.

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Speaker 1: We're very excited to get your take on the markets.

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Speaker 1: Thanks so much for joining us. We're also delighted to

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Speaker 1: welcome back Spencer Cutter, a credit analyst with Bloomberg Intelligence

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Speaker 1: based in Seattle. Great to see you against Spencer. We'll

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Speaker 1: be talking to Spencer a bit later in the show

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Speaker 1: about trouble brewing in the energy sector after gas price

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Speaker 1: is plunged. So do stay with us. But first, Alice

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Speaker 1: Wong with Bloomberg News, You're all over the China credit story,

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Speaker 1: which has for many months been mostly about distress in

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Speaker 1: the real estates sector. Some of the biggest property developers

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Speaker 1: in the world are in China, companies like Evergrande and

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Speaker 1: Country Garden. A lot of them are in deep trouble,

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Speaker 1: which has huge implications for the world's second largest economy.

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Speaker 1: That means we should all be paying a lot more attention.

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Speaker 1: It's a major global story, but break it down for us, Alice,

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Speaker 1: How bad is it right now? And how did we

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Speaker 1: get here?

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Speaker 2: Yeah? Well, one of China's biggest restructurings, ever is at

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Speaker 2: risk of falling apart before it's even officially launched, and

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Speaker 2: Evergron's billionaire founder is now placed under police control, and

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Speaker 2: the company, which was at one time the country's biggest developer,

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Speaker 2: is now facing rising risks of the potential liquidation. How

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Speaker 2: do we get here? We can stay started when the

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Speaker 2: company was binge borrowing and grew a huge det pile

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Speaker 2: to fuel growth, just like many of his peers in

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Speaker 2: the last decade, and it started hanging into trouble when

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Speaker 2: Chinese regulators cracked down on excessive borrowing in twenty twenty

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Speaker 2: and Evergrind eventually defaulted in late twenty twenty one, becoming

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Speaker 2: the highest profile casualty of the nation's property crisis that

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Speaker 2: you just described.

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Speaker 1: So what's the latest on evergram There was an arrest

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Speaker 1: or not an arrest recording it a detention here, and

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Speaker 1: they were supposed to restracture their debt that all seemed

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Speaker 1: to be going quite smoothly. Why did it fall apart.

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Speaker 2: Now. Yeah, the company was originally scheduled to hold credit

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Speaker 2: Our meetings to vote on its offshore debt restructuring plan

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Speaker 2: this week, but on late Friday, In announced cancelation of

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Speaker 2: the meetings and said it must reassess the plans. A

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Speaker 2: few days later, In announced it cannot issue new notes,

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Speaker 2: which were a crucial part of the restructuring proposal, due

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Speaker 2: to regulatory requirements, and Bloomberg reported that the billionaire chairman

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Speaker 2: Quikayan was taken away by Chinese police earlier this month

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Speaker 2: and it's being monitored at a defignated location, so that's

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Speaker 2: effectively under police control. So those are the reasons that

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Speaker 2: were given by the company. But really there's a lot

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Speaker 2: of questions lingering on investor's minds on what is going

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Speaker 2: on behind the scenes.

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Speaker 1: And so you mentioned it's the biggest debtrastructuring I guess

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Speaker 1: in China for certainly a long time. Do we know

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Speaker 1: the scale of it? I mean, I know it's very

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Speaker 1: complicated and there's loads of different bondholders all over the place,

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Speaker 1: But how much death are we talking about?

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Speaker 2: Yeah? So for evergrant itself, the offshore detastructuring plan covers

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Speaker 2: I think at least over thirty billion US dollars of

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Speaker 2: offshore debt, so that's a huge number. The company itself

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Speaker 2: has a lot more liabilities. Previously the number was closed

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Speaker 2: to three hundred billion, okay.

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Speaker 1: And it's not just Chinese investors, right, it's investors all

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Speaker 1: around the world.

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Speaker 2: Correct, there's a lot of There are a lot of

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Speaker 2: investors around the globe at stake.

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Speaker 1: So you mentioned liquidation. I mean that sounds pretty pretty extreme.

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Speaker 1: Does the company have any future at this point? I mean,

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Speaker 1: what does liquidation actually involve.

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Speaker 2: Yeah, we don't know for sure what may happen to

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Speaker 2: the company, but like you said, the risks of liquidation

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Speaker 2: are certainly rising very fast. So to bring it back

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Speaker 2: a little bit, the company faces winding up hearing at

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Speaker 2: the Hong Kong Core on October thirties, So that's just

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Speaker 2: over a month away, and there's already been a few

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Speaker 2: hearings previously, and at the last hearing, the judge urged

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Speaker 2: the company to present concrete progress, concrete restructuring progress in court.

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Speaker 2: That's the same warning that she gave to some other

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Speaker 2: developers before she issued actual winding up orders to them.

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Speaker 2: So what happens after liquidation is a liquidator can be appointed,

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Speaker 2: come into the company, dismantle a company, these the assets,

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Speaker 2: use them to sell them, and use them to repay

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Speaker 2: the creditors. There's a lot of actual procedures that are

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Speaker 2: quite clear, especially for such a big company with a

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Speaker 2: lot of debt loads. And we will actually do a

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Speaker 2: story on that to analyze what will actually happen if

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Speaker 2: ever Ran goes into liquidation. But that's like the gist

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Speaker 2: of it. So now the company needs to raise to

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Speaker 2: find a way to get over the regulatory approval, present

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Speaker 2: new restructuring terms, and get enough creditors on board to

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Speaker 2: support this new plan in just about a months.

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Speaker 1: And if there is a liquidation, how do you think

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Speaker 1: that would be received by the credit markets.

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Speaker 2: For Evergrand itself. You know, in this earlier restructuring plan,

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Speaker 2: the company says if it's forced into liquidation, the estimated

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Speaker 2: recovery rate for different creditors may range from two percent

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Speaker 2: to nine percent, But its bonds are actually indicated now

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Speaker 2: at nearly five percent of is face value. Now, so

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Speaker 2: any potential recovery will you also be undoubtedly very long.

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Speaker 2: But overall, I think more importantly the market will be

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Speaker 2: concerned about potential regulatory hurdles for other developers. If it

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Speaker 2: really comes to such a stage, one may argue that

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Speaker 2: evergham with a single event, but the lack of visibility

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Speaker 2: into the whole process which will lead up to this

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Speaker 2: potential liquidation, that may make investors doubt whether they have

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Speaker 2: any control over other restructuring situations. And when these things

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Speaker 2: are so unpredictable, how how do you even begin your

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Speaker 2: investment analysis.

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Speaker 1: So it's not just Everground there is it. I mean

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Speaker 1: there are others in trouble. We talked about Country Garden

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Speaker 1: a bit. I mean, what's what's the latest there?

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Speaker 2: Yeah, well, a lot of the sector is already in distress,

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Speaker 2: and including Country Garden, like you mentioned. So this is

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Speaker 2: the country's developer, largest developer for many many years, and

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Speaker 2: it's now in talks with financial advisors. So they're in

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Speaker 2: talks with Julianoki and China International Capital Corps both to

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Speaker 2: become financial advisors and try to put together an offshore

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Speaker 2: debt restructuring plan. The company has missed two dollar bond coupons,

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Speaker 2: the latest do yesterday their initial deadlines, and it's now

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Speaker 2: in grace periods for those bonds.

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Speaker 1: And there are other developers that we keep hearing about

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Speaker 1: as well as it's not just two big developers, it's

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Speaker 1: a whole sector in China, right.

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Speaker 2: That's correct, and we're seeing it going from you know,

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Speaker 2: country Garden ever round, which are like residential builders. Today

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Speaker 2: we wrote another story on a commercial probably developer, Thali

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Speaker 2: One Douc Group, which has also been having some troubles recently,

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Speaker 2: and they've started negotiations on a proposal that would allow

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Speaker 2: the conglomerate to avoid repaying about thirty billion yen that's

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Speaker 2: about four billion years dollar to investors if IFS unit

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Speaker 2: fails to complete an initial public offering this year. There's

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Speaker 2: also a lot of money e stake.

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Speaker 1: In simple terms, I just want to kind of back

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Speaker 1: up a bit and look at the root cause of

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Speaker 1: this problem. In there's a lot of people in China.

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Speaker 1: I mean, that's an obvious statement. People need somewhere to live.

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Speaker 1: These companies are creating housing for those people. Surely that's

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Speaker 1: a good business model. Why is it all falling apart?

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Speaker 2: Yeah, A lot of the troubles sort of started showing

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Speaker 2: up and the government attempted to crack down on these

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Speaker 2: heavily indebted developers, which, as I mentioned before, they went

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Speaker 2: on debt binging to fuel their growth. So in twenty twenty,

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Speaker 2: the government tried to crack down on them to reduce

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Speaker 2: the risk to the financial system. And what they saw is,

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Speaker 2: you know, some developers, once they started having some financial trouble,

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Speaker 2: they they will stop building the houses they have already

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Speaker 2: sold but yet to deliver, and that also then prompts

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Speaker 2: homeowners to stop paying their mortgages. So you can see

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Speaker 2: how there's a potential threat spreading through this whole financial system.

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Speaker 2: So that's why this type of turbulence was a wake

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Speaker 2: up call for China and the government I think ultimately

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Speaker 2: wants to make sure housing project delivery comes first, so

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Speaker 2: he wants to crack down on all these set issues.

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Speaker 1: So the route then is just too much debt being

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Speaker 1: putled on too quickly.

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Speaker 2: Yeah, I guess you can say that.

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Speaker 1: And in terms of the Chinese economy, how important are

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Speaker 1: these sectors to the Chinese economy, which is obviously the

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Speaker 1: second biggest in the world.

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Speaker 2: Yeah, so the property sector, I think it's it's like

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Speaker 2: shrinks a bit now, but it still makes up for

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Speaker 2: I think at least one fifth of China's GDP. And

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Speaker 2: also this is the This was meant to be the

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Speaker 2: ear that China's economy is going to roll back after

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Speaker 2: the long COVID shut shutdowns, and it's supposed to help it,

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Speaker 2: you know, power global growth again. But instead it is

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Speaker 2: facing all of these problems, and the shaky property market

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Speaker 2: is a huge part of it. Another part is also

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Speaker 2: it's impacting the municipal government's revenues because land sales to

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Speaker 2: property developers have traditionally been a very important source of

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Speaker 2: income for these local governments. So it's also drying up

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Speaker 2: the government's revenues.

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Speaker 1: Given that though, and it's you know the government, you know,

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Speaker 1: it's it's a communist government, it controls everything. Why don't

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Speaker 1: they just step in and bail everybody out?

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Speaker 2: I think, like I said, because the government now has

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Speaker 2: a very clear target, which is to ensure housing project delivery.

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Speaker 2: And they I think they have a clear target at

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Speaker 2: this time around. They don't want to repeat the debt

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Speaker 2: bingch that we have seen, so you know, once they

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Speaker 2: step in and help, we may see all of this

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Speaker 2: pattern repeat itself all over again. I think they do

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Speaker 2: want to rain and on the moral hazard in this industry.

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Speaker 1: Some people might have invested in everground debt just because

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Speaker 1: they thought it was too big to fail? Is that

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Speaker 1: something that they will end up regretting?

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Speaker 2: Clearly? Right now, that's something we're seeing a model. Well,

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Speaker 2: I don't think that is that is correct anymore. We

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Speaker 2: have seen several cases, we have seen Everyghend, we have

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Speaker 2: seen country Guard, and it really seems too big to fail.

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Speaker 2: Maybe a myth.

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Speaker 1: So what does this all say about the investibility or

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Speaker 1: or lack thereof in Chinese credit markets? I mean it is,

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Speaker 1: you know, it is a big market, it's you know,

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Speaker 1: emerging market. Investors want to invest in it because it's

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Speaker 1: such a big economy. But this problem in the sector,

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Speaker 1: you know, this crisis really I mean it's exposing a

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Speaker 1: lot of governance disclosure issues, and you know, it doesn't

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Speaker 1: make it seem a very attractive place for foreign investors.

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Speaker 1: Does it make you know, long term impact? Does that

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Speaker 1: mean pushing away foreign money?

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Speaker 2: Yeah, I think we're definitely already seeing that. I mean,

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Speaker 2: the offshore debt market has rapidly shrunk. Chinese companies, Chinese

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Speaker 2: developers have traditionally been a very important part in asia

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Speaker 2: stolarble market, and now people are not paying for their

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Speaker 2: bonds anymore. People are not buying new issuance, So the

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Speaker 2: primary issuance market has rapidly shrunk. And also, like you said,

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Speaker 2: there's a lot of potential long term impact just because

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Speaker 2: of all these governance issues and back to Evergram, where

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Speaker 2: we're seeing there is no visibility into what is going on.

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Speaker 2: Nobody really knows why all of a sudden the restructuring

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Speaker 2: plan is not getting regulatory approval. So all of these

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Speaker 2: are definitely going to investor confidence in the long run.

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Speaker 1: And when you say that there's maybe less appetite for

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Speaker 1: the new bond issues, we're talking only about real estate

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Speaker 1: developers or is it spreading to other sectors now?

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Speaker 2: Yeah, so the whole China's high yiel dollar bomb market

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Speaker 2: is being really impacted. In China's issuance in general has

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Speaker 2: come down a lot.

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Speaker 1: So before we talk to Spencer Cutter over BI about energy,

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Speaker 1: tell us us what else is on your radar? What

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Speaker 1: else should we be looking at in China?

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Speaker 2: I think the next part to watch. Apart from all

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Speaker 2: of the private developers that we just mentioned, there's a

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Speaker 2: few other names left still, there is long for there

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Speaker 2: is banky people are looking at these what it was

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Speaker 2: called stronger names and also I think with Moodies who

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Speaker 2: recently have pointed out that risks could be spreading to

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Speaker 2: some of the se names as well. So we're definitely

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Speaker 2: in addition to all of the names that we're already tracking,

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Speaker 2: we will be paying attention to the broader sector as well.

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Speaker 1: So that's state owned enterprises, right correct? Yeah, Okay, so

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Speaker 1: it's not over yet. There are lots more strands of

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Speaker 1: this story to come out. We're going to be watching

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Speaker 1: your coverage very closely. I think you know anyone who's

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Speaker 1: who's anywhere in financial markets, you know that they're not

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Speaker 1: to be in Asia. You've got to watch this one.

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Speaker 1: It's a big story, right, that's right, Great stuff. Alice

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Speaker 1: Wong from Bloomberg News, thank you so much for joining us.

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Speaker 1: Read all of Alice's scoops on the Bloomberg terminal and

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Speaker 1: of course at Bloomberg dot com. It's a huge, as

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Speaker 1: I said, developing story in the second biggest economy. Pay

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Speaker 1: attention and thanks so much again Alice coming on.

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Speaker 2: The show, Thank you for having me.

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Speaker 1: And now for something completely different, I'm delighted to welcome

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Speaker 1: back to the Credit Edge Spencer Cutter, who covers energy

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Speaker 1: for Bloomberg intelligence based in Seattle.

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Speaker 3: How are you doing, Spencer, doing great, James, Thanks for

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Speaker 3: having me.

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Speaker 1: So we've talked a lot about energy over the years,

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Speaker 1: and I always think of oil in that context. It's

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Speaker 1: obviously jumped a lot over the last few months, heading

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Speaker 1: for one hundred dollars a barrel. Again, everyone's very excited

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Speaker 1: about oil. That's presumably good for the producers of the stuff,

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Speaker 1: many of which went through some tough times over the

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Speaker 1: last decade and learned to live with much lower prices.

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Speaker 1: But we could probably come back to that a bit

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Speaker 1: later on in the show. I just wanted to start

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Speaker 1: with gas though, because it's dropped a lot this year.

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Speaker 1: Some natural gas producers may start to have problems if

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Speaker 1: prices don't improve soon. What is the situation, Spencer, You're

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Speaker 1: also covering gas. How much of a credit story is this?

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Speaker 1: And you know what are we talking about here?

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Speaker 3: Yeah, so you're right, everybody when you talk about energy

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Speaker 3: thinks automatically of oil, and people say oil and gas,

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Speaker 3: but they sort of didn't forget the natural gas part.

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Speaker 3: But that is a big component of the market, and

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Speaker 3: natural gas prices have fallen by seventy seventy five percent

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Speaker 3: over the last year. Last summer prices were north of

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Speaker 3: nine dollars per thousand cubic feet, and now that's today

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Speaker 3: at two seventy five. So it's a developing credit story.

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Speaker 3: Most of the producers, so you have companies like Southwestern Energy,

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Speaker 3: Chesapeake Energy, Entiro Resources, Range Resources, Comstock. These are all

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Speaker 3: pretty much pure player, very close to pure prey natural

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Speaker 3: gas and or natural gas liquids players, and they've spent

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Speaker 3: they had similar near death experience to the oil companies

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Speaker 3: back in twenty sixteen and twenty twenty, so they spent

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Speaker 3: a lot of time and effort over the last two

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Speaker 3: years cleaning up their balance sheets and using that nine

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Speaker 3: dollars gas price to generate a ton of free cash

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Speaker 3: flow and pay down debt. So nobody's terribly concerned yet

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Speaker 3: that natural gas is below three dollars, But if it

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Speaker 3: stays three dollars into next year, I think people may

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Speaker 3: start to get concerned because at that level, free cash

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Speaker 3: flow generation is very tight, if not for some producers

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Speaker 3: even negative and leverage ratios while still low because we're

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Speaker 3: coming off of a robust twenty twenty two and a

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Speaker 3: cycle where they've paid down debt. You know, if prices

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Speaker 3: stay low enough long enough, you will start to see

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Speaker 3: leverage ratios climb to an area that people might start

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Speaker 3: to think, maybe I should start getting a little bit

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Speaker 3: concerned here. So I think this is developing at the

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Speaker 3: end of twenty twenty three and could become a headline

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Speaker 3: in twenty twenty four if things stay where they are.

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Speaker 1: And we're talking about a lot of debt here, are

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Speaker 1: we big components of the innet? I mean some of

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Speaker 1: those names you just mentioned now, like Chesapeake, you know,

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Speaker 1: definitely they are parts of the junk index. But is

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Speaker 1: this a big part of credit investors portfolios?

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Speaker 3: It's well, it's less than it used to be, And

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Speaker 3: it depends on how far back you want to go.

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Speaker 3: So if you want to go back to pre twenty fifteen,

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Speaker 3: it would have been a much bigger segment. But then

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Speaker 3: you had a huge wage the biggest wave of bankruptcies

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Speaker 3: in the oil and gas sector in history in twenty

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Speaker 3: fifteen and sixteen, So that wiped out a lot of

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Speaker 3: the debt and a lot of the sketchier credits, and

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Speaker 3: then you had some other bankruptcies in twenty twenty when

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Speaker 3: prices plunged then so and then as I mentioned companies

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Speaker 3: that have survived or like Chesapeake, went bankrupt and emerged

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Speaker 3: with a lot less debt have then used the cash

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Speaker 3: flow that they've generated over the last couple of years

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Speaker 3: to pay down the debt. So it is a you know,

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Speaker 3: if you're in the oil and gas high yield oil

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Speaker 3: and gas space, yes, natural gas is a significant component

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Speaker 3: of the credit quality of that subsector. If you're talking

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Speaker 3: about the larger hiled energy sector, which includes oil producers, services,

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Speaker 3: and drillers, it's it's still you know, it's still a

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Speaker 3: still something you need to keep an eye on, but

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Speaker 3: it's smaller than it was five years ago.

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Speaker 1: And as you say, the free cash flow generation is

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Speaker 1: dropping quite steeply and in some cases will be negative.

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Speaker 1: Will be talking about another distress cycle potentially for gas.

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Speaker 3: Well again, so it's developing. And if most of these

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Speaker 3: companies need prices somewhere north of three dollars per thousand

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Speaker 3: cubic feet of natural gas produced in order to be

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Speaker 3: able to sustain some element of free cash flow and production.

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Speaker 3: And there's a there's a trade off here because a

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Speaker 3: company can increase production or maintain the current level of production.

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Speaker 3: But since we're talking about shale drilling here and fracking.

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Speaker 3: It's very capital intensive, so you're on this treadmill, this

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Speaker 3: capital treadmill. So even if you just want to keep

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Speaker 3: your production flat, you still may need to spend a

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Speaker 3: billion dollars every year in cappex to keep drilling new

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Speaker 3: wells as your old wells start to run dry. So

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Speaker 3: they can do that, but if oil or sorry, if

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Speaker 3: natural gas prices are below three dollars, they may need

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Speaker 3: to start incurring debt in order to do that, and

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Speaker 3: then you start seeing leverage ratios climb if prices continue

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Speaker 3: to remain low. So it becomes this trade off of

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Speaker 3: do you want to which is more important to you?

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Speaker 3: Do you want to maintain production in which case, if

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Speaker 3: prices are below three dollars, you may need to borrow

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Speaker 3: to do that, or do you want to maintain a

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Speaker 3: neutral free cash flow profile at least in which case

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Speaker 3: you may need to start cutting back on capex, which

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Speaker 3: then cuts back up production, which if that cycle continues

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Speaker 3: for several years, or you know, a year and a

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Speaker 3: half to two years, can lead to a pretty negative

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Speaker 3: feedback loop.

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Speaker 1: Is there anything to make us think that there might

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Speaker 1: be a big rally in gas priceice anytime soon. I mean,

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Speaker 1: I guess the increased oil production and that comes on

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Speaker 1: because high over prizes, that doesn't help.

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Speaker 3: Yeah, so higher oil prices leading to more oil drilling

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Speaker 3: doesn't help because oil is not the only thing that

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Speaker 3: comes out of the walhead. From ninety nine percent of

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Speaker 3: the oil wells that they're being drilled, you know, in

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Speaker 3: the premium basin, which is when it gets all the headlines,

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Speaker 3: they're all producing a certain amount of natural gas, and

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Speaker 3: so that they're drilling for oil, but they're coming up

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Speaker 3: with oil and gas. They put that gas into the

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Speaker 3: pipeline and it goes to the hub, and it's just

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Speaker 3: more gas production when the market doesn't need it. What

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Speaker 3: the market really is hoping for is for liquefied natural

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Speaker 3: gas exports to increase, and there are that market has

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Speaker 3: expanded pretty dramatically over the last five years, and there

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Speaker 3: are more projects coming online. They may not come online

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Speaker 3: really until twenty twenty five, so you still have another

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Speaker 3: year or so, but that the producers are really kind

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Speaker 3: of hanging a hat on. Export demand will grow and

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Speaker 3: that should then soak up some of the excess supply

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Speaker 3: drive prices higher. Plus more natural gas fired power plants

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Speaker 3: and demand you know from just general economic growth should help,

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Speaker 3: but that's another Like I said, it's potentially two years away.

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Speaker 3: And the biggest swing over the short term is weather

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Speaker 3: because gas is used, as I mentioned, to generate electricity.

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Speaker 3: So if you have a really mild winter in the Northeast,

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Speaker 3: where most of the US population is centered, then there's

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Speaker 3: less demand for gas and storage levels will be high

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Speaker 3: going into the winter. That would keep prices low. If

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Speaker 3: you have a really cold winter, that might help, But

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Speaker 3: it's the longer term. Hope is that exports will come

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Speaker 3: online and expand and drive up domestic prices as more

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Speaker 3: and more gas leaves the US market and goes overseas.

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Speaker 1: Meanwhile, though, credit spreads in this sector are pretty much

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Speaker 1: where they were a year ago when natural gas was

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Speaker 1: double the price. How does that work? And you know,

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Speaker 1: I mean, I know, credit spreads are very tight across

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Speaker 1: the board for various technical reasons, but can that actually last?

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Speaker 3: Yeah, it's an interesting dynamic. Most of the companies, the

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Speaker 3: credit spreads on their bonds, like you said, are pretty

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Speaker 3: much today where they were a year ago when price

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Speaker 3: natural gas was seven to nine dollars for a thousand

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Speaker 3: cubic feet versus like we said two seventy five today,

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Speaker 3: Comstock Resources they saw their spreads widen by over one

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Speaker 3: hundred bases points in the interim, but that's come right

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Speaker 3: back down even though the market is still relatively weak.

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Speaker 3: I think it's a combination of lack of supply and

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Speaker 3: not talking to gas supply, but bond supply. These companies

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Speaker 3: have paid down debt. As I mentioned, their credit ratios

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Speaker 3: are still pretty strong even with prices being low today.

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Speaker 3: But like I said, if that continues into next year,

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Speaker 3: I think you will start to see some deterioration. Borrowing

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Speaker 3: based credit facilities so far have been untouched, but they

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Speaker 3: may start to take a hit this year or at

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Speaker 3: the end of this year. But I just think it's

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Speaker 3: I think the market is kind of looking past the

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Speaker 3: current downturn, hoping that export capacity does come online, and

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Speaker 3: is saying, look, credit ratios are still pretty strong. I

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Speaker 3: shouldn't worry yet, and maybe they're right. But if this,

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Speaker 3: like I'm said, if this trend continues, it could be

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Speaker 3: a developing story in twenty twenty four.

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Speaker 1: Let's talk about that borrowing base. I mean it is.

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Speaker 1: I'm going to expose myself as a real credit geek here,

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Speaker 1: but it is one of my favorite stories about energy

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Speaker 1: that every once or twice a year this thing comes up.

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Speaker 1: What is it in basic terms and why does it matter?

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Speaker 2: Hit?

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Speaker 3: Yeah, So, borring based credit facilities as it relates to

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Speaker 3: oil and gas companies is primarily a high yield type

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Speaker 3: of loan, and it think of it as you know,

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Speaker 3: your credit card for a company, revolving credit facility, and

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Speaker 3: it's a way for banks to get comfortable lending a

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Speaker 3: little bit more money to a non investment grade oil

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Speaker 3: or gas producer whose fortunes are at the whim of

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Speaker 3: highly vault commodity prices. So they don't want to lend

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Speaker 3: a company, you know, a billion dollars and then find

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Speaker 3: out that oil prices go from ninety dollars to thirty

431
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Speaker 3: dollars and then all of a sudden they're stuck. So

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Speaker 3: it's a way that they set their their borrowing limit

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Speaker 3: at a certain amount, and then every six months they

434
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Speaker 3: generally will go back and look at the company's reserves

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Speaker 3: and production profile and say, okay, oil prices are ninety

436
00:24:25,480 --> 00:24:29,440
Speaker 3: dollars and you're an oil producing company, We're feeling very comfortable.

437
00:24:29,480 --> 00:24:31,600
Speaker 3: We will raise your borrowing base and we're willing to

438
00:24:31,640 --> 00:24:33,440
Speaker 3: lend you a little more money. And then six months later,

439
00:24:33,440 --> 00:24:37,440
Speaker 3: if oil goes down to fifty dollars, they'll come and say, okay,

440
00:24:37,440 --> 00:24:40,199
Speaker 3: well we're not as comfortable. We're going to cut that

441
00:24:40,760 --> 00:24:43,879
Speaker 3: borrowing capacity by a bit. So it's it's a so

442
00:24:43,880 --> 00:24:46,119
Speaker 3: it's a generally in every six months, in the spring

443
00:24:46,160 --> 00:24:48,720
Speaker 3: and in the fall. And what's happening with natural gas

444
00:24:48,800 --> 00:24:52,280
Speaker 3: is these borrowing bases were set, you know, two three

445
00:24:52,320 --> 00:24:56,000
Speaker 3: billion dollar levels for companies like Southwestern Antario and Chesapeake,

446
00:24:56,000 --> 00:25:00,520
Speaker 3: and they were set last year when prices were still high,

447
00:25:00,560 --> 00:25:03,760
Speaker 3: and the banks haven't really touched them yet. They've went

448
00:25:03,800 --> 00:25:07,040
Speaker 3: through a redetermination a year ago when price at natural

449
00:25:07,080 --> 00:25:09,399
Speaker 3: gas prices had started to fall. They went through another

450
00:25:09,400 --> 00:25:11,800
Speaker 3: one in the spring of this year when prices were

451
00:25:11,840 --> 00:25:15,440
Speaker 3: still low, and they generally they don't want to overreact

452
00:25:15,520 --> 00:25:19,080
Speaker 3: to what may be a short term move in the

453
00:25:19,080 --> 00:25:21,639
Speaker 3: commodity price, so they kind of let things lie for

454
00:25:21,680 --> 00:25:24,159
Speaker 3: a while. But it's now been over a year and

455
00:25:24,200 --> 00:25:29,640
Speaker 3: I do think that producer or borrowers may find that

456
00:25:29,720 --> 00:25:31,760
Speaker 3: banks are saying, yeah, we're we're starting to get a

457
00:25:31,760 --> 00:25:34,080
Speaker 3: little bit more worried about this, because this downturn is

458
00:25:34,160 --> 00:25:36,679
Speaker 3: lasting a little longer than maybe we originally thought. So

459
00:25:37,600 --> 00:25:42,199
Speaker 3: let's take that two billion dollar commitment and cut it

460
00:25:42,240 --> 00:25:45,760
Speaker 3: down to you know, one point seven billion or one

461
00:25:45,760 --> 00:25:48,800
Speaker 3: and a half billion, and you know, mitigate our risk

462
00:25:48,880 --> 00:25:50,760
Speaker 3: a little bit that if the prices stay low, that

463
00:25:50,840 --> 00:25:51,960
Speaker 3: things could get a little worse.

464
00:25:52,880 --> 00:25:55,119
Speaker 1: Can that happen any time over the next few weeks

465
00:25:55,160 --> 00:25:55,639
Speaker 1: or months now?

466
00:25:56,280 --> 00:25:59,800
Speaker 3: It should so the most there's this there is a

467
00:25:59,800 --> 00:26:04,000
Speaker 3: sea into it, and most companies will go through that process,

468
00:26:05,080 --> 00:26:08,240
Speaker 3: probably in late October, and you'll start to see press

469
00:26:08,240 --> 00:26:10,400
Speaker 3: releases coming out at the end of October in early

470
00:26:10,440 --> 00:26:14,040
Speaker 3: November with companies announcing the results of their borrowing base

471
00:26:14,280 --> 00:26:15,600
Speaker 3: redetermination process.

472
00:26:17,400 --> 00:26:20,480
Speaker 1: So other than the banks who might lower the amount

473
00:26:20,520 --> 00:26:22,960
Speaker 1: that some of these companies can borrow, what point do

474
00:26:23,080 --> 00:26:25,880
Speaker 1: the bondholders start to worry and start to sell these

475
00:26:25,920 --> 00:26:28,440
Speaker 1: bonds And when do these spread start to flare out again?

476
00:26:28,880 --> 00:26:33,000
Speaker 3: I think it's if we get through this winter without

477
00:26:34,000 --> 00:26:38,000
Speaker 3: your usual winter bump in prices. I think at that

478
00:26:38,080 --> 00:26:40,960
Speaker 3: point the market might start to say, huh, there may

479
00:26:41,000 --> 00:26:44,600
Speaker 3: be something more systemic here. In longer term, I might

480
00:26:44,680 --> 00:26:48,320
Speaker 3: want to reassess whether I really believe prices are going

481
00:26:48,400 --> 00:26:51,800
Speaker 3: to rebound and then within the next year, as everyone

482
00:26:51,800 --> 00:26:53,560
Speaker 3: seems to have been thinking for the past year.

483
00:26:54,240 --> 00:26:56,919
Speaker 1: But it seems unlikely. You know.

484
00:26:57,040 --> 00:27:00,240
Speaker 3: Again, like I said, it's a weather driven phenomen on.

485
00:27:00,320 --> 00:27:03,760
Speaker 3: It's hard to predict. But if we get a mild winter,

486
00:27:04,359 --> 00:27:07,119
Speaker 3: then I think that could start to drive some some reaction.

487
00:27:08,680 --> 00:27:11,600
Speaker 1: Are there any potential winners or losers you appoint to

488
00:27:11,600 --> 00:27:15,000
Speaker 1: in this, You.

489
00:27:14,960 --> 00:27:21,080
Speaker 3: Know, the the losers would be the more risky and

490
00:27:21,200 --> 00:27:28,120
Speaker 3: smaller natural gas producers. Comstock Resources is their credit spreads,

491
00:27:28,400 --> 00:27:30,480
Speaker 3: though they are back to where they were a year ago,

492
00:27:30,520 --> 00:27:32,960
Speaker 3: are still somewhat wider than most of their peers. And

493
00:27:33,000 --> 00:27:36,879
Speaker 3: they are the one company that most or several analysts

494
00:27:37,400 --> 00:27:40,960
Speaker 3: think will generate negative free cash for this year. So

495
00:27:41,000 --> 00:27:43,480
Speaker 3: if prices stay stay low in the next year, that

496
00:27:43,480 --> 00:27:46,800
Speaker 3: could just get worse. But then you have companies like

497
00:27:46,880 --> 00:27:51,359
Speaker 3: Chesapeake Energy, which everybody who knows Chesapeake knows it from

498
00:27:51,920 --> 00:27:54,159
Speaker 3: you know, the good old days when they were you know,

499
00:27:54,200 --> 00:27:57,119
Speaker 3: the big cowboys of the wild West and slinging money

500
00:27:57,520 --> 00:28:01,000
Speaker 3: left and right and highly levered. That's completely different. Now

501
00:28:01,040 --> 00:28:04,560
Speaker 3: they have pared down their business, cut down a lot

502
00:28:04,560 --> 00:28:07,320
Speaker 3: of debt, and they will probably still have one of

503
00:28:07,320 --> 00:28:10,320
Speaker 3: the lowest leverage ratios of their peer group going in

504
00:28:10,480 --> 00:28:11,280
Speaker 3: through a downturn.

505
00:28:13,160 --> 00:28:16,040
Speaker 1: So just briefly, as we started the conversation talking about oil,

506
00:28:16,080 --> 00:28:18,040
Speaker 1: I just wanted to flip that to that, you know,

507
00:28:18,200 --> 00:28:22,440
Speaker 1: just really sort of high leveled stuff. High oil prices,

508
00:28:22,480 --> 00:28:25,040
Speaker 1: you know, ninety dollars a barrel maybe heading towards one hundred.

509
00:28:25,280 --> 00:28:27,280
Speaker 1: A lot of these guys already, you know, used to

510
00:28:27,320 --> 00:28:30,560
Speaker 1: dealing with much lower. Surely this is a big windfall

511
00:28:30,640 --> 00:28:34,639
Speaker 1: for credit, does it? Does it boost high yield energy

512
00:28:34,720 --> 00:28:36,240
Speaker 1: bonds across the bord or is it all going to

513
00:28:36,280 --> 00:28:37,080
Speaker 1: go to equity holders.

514
00:28:37,119 --> 00:28:38,920
Speaker 3: It's all going at this point, It's all going to

515
00:28:38,920 --> 00:28:41,880
Speaker 3: equity holders. The only the only companies I think that

516
00:28:42,320 --> 00:28:45,000
Speaker 3: benefit from the higher oil prices at this point are

517
00:28:45,320 --> 00:28:50,000
Speaker 3: the still highly levered and somewhat I don't say troubled,

518
00:28:50,040 --> 00:28:53,719
Speaker 3: but coming out of a troubled market oil field service

519
00:28:53,920 --> 00:28:58,880
Speaker 3: companies and drilling companies. So companies like Transocean, Weatherford neighbors,

520
00:28:59,000 --> 00:29:02,920
Speaker 3: who are still trading pretty high yields relative to their peers.

521
00:29:02,960 --> 00:29:06,680
Speaker 3: They still have a decent amount of debt not a

522
00:29:06,840 --> 00:29:09,080
Speaker 3: have not had a huge amount of free cash flow

523
00:29:09,160 --> 00:29:14,320
Speaker 3: as producers have sort of maintained a relatively you know,

524
00:29:14,880 --> 00:29:17,400
Speaker 3: lower than you might expect level of drilling activity. But

525
00:29:17,480 --> 00:29:21,320
Speaker 3: as prices go higher, those companies should benefit, But most

526
00:29:21,360 --> 00:29:25,000
Speaker 3: of the actual oil producers, they've also cut down on

527
00:29:25,080 --> 00:29:27,040
Speaker 3: a lot of their debt over the last couple of years,

528
00:29:27,880 --> 00:29:30,600
Speaker 3: and they've started, you know, they've hit their their leverage

529
00:29:30,640 --> 00:29:33,760
Speaker 3: targets and their debt targets, and now they're all using

530
00:29:33,760 --> 00:29:36,120
Speaker 3: all the free cash so that they generate fifty to

531
00:29:36,120 --> 00:29:37,960
Speaker 3: seventy five percent of the free cash so they generate

532
00:29:37,960 --> 00:29:40,840
Speaker 3: and using that to buy back stock and pay variable dividends.

533
00:29:40,920 --> 00:29:43,480
Speaker 3: So I don't think creditors are really going to get

534
00:29:43,480 --> 00:29:48,160
Speaker 3: any upside from ninety one hundred and twenty dollars oil prices.

535
00:29:48,320 --> 00:29:51,000
Speaker 1: Thanks very much, Spencer Cutter of Bloomberg Intelligence. You can

536
00:29:51,040 --> 00:29:53,480
Speaker 1: read all of his great analysis on the Bloomberg Terminal.

537
00:29:53,520 --> 00:29:55,040
Speaker 1: Do check it out, and we hope to see you

538
00:29:55,080 --> 00:29:57,360
Speaker 1: back on the show again soon. Spencer Great, Thanks a lot,

539
00:29:57,680 --> 00:30:00,480
Speaker 1: and thanks again to Alice Swong from Bloomberg. Use read

540
00:30:00,520 --> 00:30:03,040
Speaker 1: all of her great China scoops on the terminal and

541
00:30:03,120 --> 00:30:06,520
Speaker 1: at Bloomberg dot com, and please do subscribe wherever you

542
00:30:06,600 --> 00:30:09,920
Speaker 1: get your podcasts. We're on Apple, Google and Spotify. Give

543
00:30:09,960 --> 00:30:12,160
Speaker 1: us a review, tell your friends, or email me directly

544
00:30:12,280 --> 00:30:16,920
Speaker 1: at jcrombeight at bloomberg dot net. That's j C R

545
00:30:16,920 --> 00:30:19,200
Speaker 1: O M B I E as in my surname and

546
00:30:19,320 --> 00:30:23,440
Speaker 1: the number eight at Bloomberg dot net. I'm James Crombie.

547
00:30:23,480 --> 00:30:25,520
Speaker 1: It's been a pleasure having you join us again. Next

548
00:30:25,520 --> 00:30:26,920
Speaker 1: week on the Credit Edge