New York/London, May 6 2015 — New analysis by the Carbon Tracker Initiative (CTI) published today shows that some US shale oil and gas companies have limited protection from oil prices falling further, especially as their hedging positions expire in 2016.

As Chesapeake announces its first quarter 2015 results today, the impact of increased oil price volatility on asset values and revenues will become clearer. Investors are keen to understand how sensitive the debt arrangements of US shale companies are to further sustained price drops.

“Hedges have given US shale oil and gas a soft landing so far from the fall in oil and gas prices. We haven’t yet seen the full impact on cash flows of OPEC trying to protect market share against increasing US shale production,” said James Leaton, Research Director at Carbon Tracker.

The study focused on five of the largest pure-play U.S. exploration and production (E&P) shale oil and gas companies, by market capitalisation. These companies are: Continental Resources; Concho Resources; Chesapeake; Whiting Petroleum; and Energen Corp.

The analysis shows that if oil and/or gas prices fall much lower, some US shale companies may need to consider restructuring their debt or renegotiating their credit facility covenants.

The study analysed the impact of lower commodity prices through the covenants that these companies have agreed with their senior creditors. These covenants are financial limits beyond which companies should not cross. Typically they are a ratio of debt and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA).

“These companies have weathered the storm of plunging commodity prices so far, but some of them have been heavily reliant on hedging positions which largely expire at the end of this year,” said Gerard Wynn an advisor to Carbon Tracker who co-authored the report.

“If commodity prices fail to climb as some are hoping or assuming, then these companies may have to resort to new tactics not to exceed these covenants.”

Companies have had a sizeable cushion against falling oil and gas prices, with Chesapeake’s revenues boosted by up to 40% ($1.2billion) of projected cash flow this year coming from hedging gains at recent oil and gas prices, (assumed to be $58/bbl WTI oil and $2.5/mmbtu natural gas). All of the companies see a decline in hedged oil volumes next year (see figure below).

Companies have several options and tactics to hold off credit problems. These include: raising capital in both equity and bond markets; asset sales; and cuts in costs and capital expenditure, as well as restructuring their debt or renegotiating their covenants.

Investors need to be aware of their exposure to high yield bonds, given the on-going price volatility. However, investors this year are piling into US E&P companies with record amounts of capital, far from considering the new risks posed by the sector.

March saw record monthly equity raisings by all US E&P companies, worth $3.8 billion, according to Bloomberg data. And E&P companies have already issued this year to April some $18 billion of new junk bonds, which is half the amount still outstanding for all 2014.

Crude oil hedges above $58 WTI floor, quarterly volumes, 2015-2016

Past analysis by the Carbon Tracker Initiative has shown that there is an excess of available fossil fuels in the ground, compared with what the world can safely burn and stay within 2 degrees Celsius average global warming. Countries have agreed that 2⁰C is a threshold for more dangerous climate change, in U.N. climate negotiations.

The excess of proven fossil fuels has been referred to as “unburnable carbon”. Investing in exploration and development of such assets risks incurring losses, where the assets are ultimately uneconomic, or stranded, for example, as a result of tougher climate policies, cheaper alternatives or demand erosion and price volatility.

US shale oil and gas illustrate the rising marginal cost of development of the world’s remaining oil and gas reserves. Shale assets generally have higher break-even prices than many conventional sources of oil and may therefore be more vulnerable to stranding.