CONTINENTAL RESOURCES: Example Of What Is Horribly Wrong With The U.S. Shale Oil Industry

According to Continental Resources website, it labels itself as America’s oil champion.  To be a champion, one is supposed to be winner.  Unfortunately for Continental, it’s taking a serious beating and is a perfect example of what is horribly wrong with the U.S. Shale Oil Industry.

During the beginning of the U.S. shale energy revolution, the industry stated it would make the United States energy independent.  The mainstream media picked up this positive theme and ran with it.  Americans who wanted to believe in this “Growth forever” notion, had no problem going further into debt to buy as much crap as they could to fill their homes with and additional rental storage units.

For several years, the U.S. Shale Revolution seemed like it was going to defy the laws of gravity (and finance) to provide the country with limitless oil production forever.  However, something started to go seriously wrong as these shale oil companies reported their financial earnings.  One by one, these oil companies financial losses and debts continued to pile up.

And a perfect example, or the “Poster child”, of what is horribly wrong with the U.S. Shale Oil Industry is none other than Continental Resources.

Again, if you go to Continental Resources website, they proudly label themselves as “America’s Champion Oil Company”:

(courtesy of Continental Resources)

Maybe Continental was America’s oil champion at one time, however if we look at their financial results, they have been receiving some serious blows to their mid section.  Looking at the company’s free cash flow since 2010, it isn’t a pretty picture:

From 2010 to 2016 YTD (year to date – Q3 2016), Continental (ticker CLR) has spent a stunning $7.6 billion more on capital expenditures (CAPEX) than they made in operating cash.  Of course this had a negative impact on their balance sheet.  In that same time period, Continental’s long-term debt surged seven times higher from $926 million in 2010 to $6.8 billion in 2016 YTD:

Continental’s long-term debt declined in 2016 partly due to the liquidating of their Washakie Basin leasehold properties in Wyoming.  They used the sale of this asset to pay down their debt.  While selling assets are a positive way to lower one’s debt, it could have a negative impact on the company’s ability to build or maintain future oil and gas production.

Moreover, for Continental to build oil production in the future, it has to spend even more money.  Actually, this is exactly what Continental Resources has been doing ever since it jumped full speed ahead onto the Shale Energy Bandwagon.  However, capital spending peaked in 2014 and has plummeted to lows not seen in more than six years:

As we can see in the chart above, Continental’s CAPEX spending peaked in 2014 at $4,717 million ($4.7 billion), and declined to only $885 million 2016 YTD.  How does Continental plan on maintaining or building oil production by selling assets or cutting its CAPEX spending by two-thirds?  Maybe Continental can defy gravity after all.

Also, it’s worth noting that the reason Continental Resources free cash flow (shown in the first chart above) declined to only a negative $20 million during the first three-quarters of 2016, was due to the oil company cutting its capital expenditures by more than $2 billion compared to the prior year.

Looking at the data in these charts, we can plainly see the CHAMP (Continental), is heading for serious trouble…. but it gets even worse.

There is this little financial metric called “Debt To Equity Ratio.”  The debt to equity ratio shows us just how healthy a company’s balance sheet truly is.  According to Investopedia’s definition of the debt to equity ratio:

Debt/Equity Ratio is a debt ratio used to measure a company’s financial leverage, calculated by dividing a company’s total liabilities by its stockholders’ equity. The D/E ratio indicates how much debt a company is using to finance its assets relative to the amount of value represented in shareholders’ equity.

So, what is Continental Resources debt to equity ratio?  All I can say… it ain’t good:

Again, to get the debt to equity ratio, we divide the company’s total liabilities by its shareholder equity (total assets minus total liabilities).  A healthy debt/equity ratio is shown as a low number (olive color).  When the debt/equity ratio climbs over “1” (red color), the majority of its assets are financed through debt.

David Dreman’s analysis for Continental’s debt to equity was as follows:

LOOK AT THE TOTAL DEBT/EQUITY: [FAIL]

The company must have a low Debt/Equity ratio, which indicates a strong balance sheet. The Debt/Equity ratio should not be greater than 20%. CLR’s Total Debt/Equity of 160.36% is not acceptable.

The Debt/Equity ratio of 160.36% corresponds with the 1.60 ratio shown in my chart above.  Not only is Continental Resources debt/equity ratio above the number “1′ line in the sand, it is 60% higher.  This is very bad news for America’s oil champion.

So, the question that many investors are wondering about… how is Continental financing all this debt they now have on their balance sheet.  That is a great question.  Actually, there is one more financial metric that gauges a company’s health by its “Interest Coverage.”

Interest coverage for Continental Resources defined by Gurufocus.com:

Interest Coverage is a ratio that determines how easily a company can pay interest expenses on outstanding debt. It is calculated by dividing a company’s Operating Income (EBIT) by its Interest Expense. Continental Resources Inc’s Operating Income for the three months ended in Sep. 2016 was $-93 Mil. Continental Resources Inc’s Interest Expense for the three months ended in Sep. 2016 was $-82 Mil. Continental Resources Inc did not have earnings to cover the interest expense. The higher the ratio, the stronger the company’s financial strength is.

Because Continental Resources operating income came in at a loss of $93 million for the third quarter of 2016, it couldn’t even pay the interest on its debt of $82 million that quarter.

The rule of thumb as it pertains to the interest coverage ratio, is that the higher the number, the healthier the company’s balance sheet.  Here is Continental’s interest coverage ratio going back until 2007:

Here we can see that Continental enjoyed very high interest coverage ratios in 2007 and 2008… the time before it got NECK DEEP into the wonderful world of shale oil and gas production.  As the price of oil and gas plummeted in 2015 and 2016, Continental’s operating earnings couldn’t even cover its interest on debt payments.

For example, in 2015, Continental had to fork over an interest payment of $313 to the kind and charitable Wall Street Banks.  Unfortunately, it suffered an operating income loss of $224 million… thus it was unable to pay its interest on debt payment.  Sadly, a company can’t pay its bills if it doesn’t make the profits.

Well, maybe things will get better for the U.S. oil champion once the disintegrating U.S. and global economies “magically” turn around and head back up in high gear.  Then again… maybe it won’t.

If I had to put my money on it, I would wager the financial situation in the U.S. oil and gas industry will continue to disintegrate.  To make matters even worse, the East Cost petroleum gasoline inventories are at record levels.  Refiners are not only turning away incoming tankers, they are now exporting gasoline.

Furthermore, Hedge Funds have never been this long in crude oil.  When investors are seen to be piling into a trade in record numbers, normally this indicates a correction is likely.  In addition, CNBC gadfly Dennis Gartman, stated he was “Going Long Oil.”  Anyone familiar with Dennis Gartman’s track record, is that when he makes a call on the direction of the stock, bond or commodity, the opposite usually occurs.

So, if the fundamentals are pointing to a WEAKENING oil market, logic suggests the oil price will head lower.  Thus, lower oil prices will only add more pain to an industry that is already suffering a great deal of trouble and misery.

That being said, I have nothing against Continental Resources or the people who work at the company.  Most are probably doing the best they can to provide much-needed oil to Americans.  However, the deteriorating financial situation at Continental can not be ignored.

I would imagine in less than five years, the U.S. oil industry will resemble nothing like it is today.  This is extremely bad news for a country that has one hell of a large SUBURBAN LEECH AND SPEND ECONOMY that can only survive if the oil continues to flow.

IMPORTANT NOTE:  I will be publishing a very interesting article this week on how the gold market has been controlled and manipulated since Nixon dropped the Gold-Dollar peg in 1971.

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21 Comments on "CONTINENTAL RESOURCES: Example Of What Is Horribly Wrong With The U.S. Shale Oil Industry"

  1. Steve,

    So how has Continental’s stock doubled in price over the last year?
    What is missing?

    Thanks,

    SteveW

    • Because all that printed money is going to their company’s stock as well.

    • I guess its the same reason the Venezuelan stockmarket quadrippled in de past few years.

      Buy some CLR. Price will double again as soon as the FED starts buying corporate oil bonds.

    • Steve,

      CLR’s stock price likely doubled since the beginning of 2016, because the price of oil jumped from a low of $28 to $54 currently.

      steve

  2. Mae Tae Smashu | February 22, 2017 at 2:55 am |

    Small typo in which assets & liabilities are switched around?
    “Again, to get the debt to equity ratio, we divide the company’s total liabilities by its shareholder equity (total liabilities minus total assets).”

    I believe debt : equity = total liabilities / (total ASSETS minus total LIABILITIES)

    Hopefully this clarifies for those following along at home. Regardless, I love these digs into the financial statements and making it so obvious that valuations, at least based on things like future cash flows, are ludicrous without high EROI energy sources.

    • Mae Tae Smashu,

      Yes, I saw that typo. Thanks, I made the correction. And I totally agree with you. When we really start to look into the financials of these companies, there is little left to imagination of what is really going on.

      steve

    • The question is, how long can our financial overlords manage to keep this monetary levitation going (and keep the rates low). And this, is anyone’s guess. If stock markets caved in by say 25%, I am sure the whole system would collapse… so to prevent that they print print print… Our national bank (SNB) is probably the world’s #1 printer (given the size of the swiss economy and swiss frank), and thereby desperately try to devalue the frank against the Euro (main trade partner) and the U$. They just add billions each month to their already bloated balance sheet, they own tons of apple stock, it’s insane, but I don’t see them stop anytime soon. Yes, I get to buy highly discounted metals and will be proven right when it all ends, but until it all ends, we metals holders look like the biggest fools. We just don’t know what our CBanksters discuss over tea over at the B(i)S… We sure are living “interesting times”, that’s for sure.

      Thank you Steve for all your insights and sharing your research.

  3. Unless i missed it there is no mention of the level of oil production they have acieved , the capex it requires to hold that level flat, and the cash flow that would be produced in today’s price environment from that production.

    • Tom,

      While it’s true that Continental Resources has increased production over the past seven years, they should have made significant free cash flow for all their efforts. We must remember, shale oil wells suffer severe decline rates in just the first few years. A typical shale oil well could experience a 75% decline in oil production in just the first 3-4 years.

      So, they have to make their money quickly. The notion that a shale oil well will be around for decades producing oil is a fantasy as the cost to maintain and lift the oil becomes prohibitive.

      steve

  4. Great work Steve, I must admit today’s financial Markets have nothing to do with realty anymore. I wonder that this house of cards didn’t collapse already. The facts that in can`t go on much longer are so convincing. But nothing is happening it seem the Ponzi can go on forever.

    • Juergen Heil,

      Agreed. For the Shale Oil Miracle to work, the industry needed ZERO INTEREST RATES. This is true for two reasons:

      1) Zero interest rates forced investors searching for yield, to put their money in the shale energy industry, because they were paying higher rates.

      2) Zero interest rates allowed the shale energy industry to finance its ever increasing debt at very low quarterly payments. If the market had a more realistic interest rate of say 5-7%, the entire shale energy industry would have not grown to the level it has or would have already collapsed.

      steve

  5. I try explain these concepts to people and they look at me like I’m nuts or just some doom and gloomer. Another reaction is this couldn’t possibly happen because they would have been told about it. I do own stocks but I believe it’ll be industries that will get the remaining net energy left over in the system and those companies that I have selected are just educated guesses. I’m 40% stocks 60% pm’s a mix of silver gold platinum

    • Adam,

      Correct… people in the real world have been HOODWINKED by the Mainstream press to believe in a reality that is totally inconsistent to what is really taking place, either in the market fundamentals or in politics.

      I rarely, if ever get into a debate or chat with someone in the public on these issues. It is totally useless. They have been programmed to believe a certain way. It would take a lot of time to DEPROGRAM individuals before they are able to understand what is really going on.

      For those who have an open mind and are interested to know, this still takes time. I continue to receive emails from readers who say, THEY FINALLY GET THE ENERGY SITUATION!! Hell, it took me years of research to finally see the light.

      Thus, the United States and world will likely suffer the SENECA CLIFF because the system has been pushed up to a level that it is totally unsustainable. When the collapse really starts to take place, it will be swift and quick.

      steve

  6. Steve

    What would be the debt to equity ratio for other major oil companies and other key industry companies like Ford, Apple, Monsanto as a comparison?

    Thanks
    Dale

    • Dale Wilker,

      The DEBT/EQUITY RATIO is different ratio for different industries. So, it isn’t valid to compare these ratios to the energy industry. However, here are some Debt/Equity Ratios on some of the U.S. oil companies in two different time periods:

      Debt/Equity Ratios

      ExxonMobil 2006 = 0.07 / 2016 = 0.27
      Chevron 2006 = 0.09 / 2016 = 0.31
      ConnocoPhillips 2006 = 0.24 / 2016 = 0.79
      Chesapeake 2006 = 0.66 / 2016 = -8.13 (yes, that is a negative)
      Devon Energy 2007 = 0.36 / 2016 = 1.71
      EOG Energy 2006 = 0.13 / 2016 = 0.59

      These are just a few, but the TELLTALE sign is the increased DEBT/EQUITY ratio in all oil companies. While some still have long Debt/Equity ratios, they are still climbing. I don’t see this reversing anytime soon, if ever. Thus, the situation in the U.S. oil sector will continue to disintegrate going forward.

      steve

  7. This article makes perfect sense and is easy for me, a non financial expert, to understand, in contrast to the fascinating theory of the paradoxical collapse of future oil prices because of inability to get oil out of the ground (because you need another barrel of increasingly scarce oil to supply the energy to get the next barrel of oil out of the ground. ) You can not borrow money, you can not buy or sell oil land lease rights or apply economic argument of supply and demand or substitution. You ultimately need the energy in a barrel of oil to pump the next barrel out of the ground.

    Right now, we have surplus of oil so we can “afford” to pay one barrel of oil to get 5 out of the ground. We also have demand destruction I believe from an economy that is slowing down because of debt burden, which paradoxically masks the energy return on energy investment dilemma for the time being, which if I understand you correctly, will take over as the ultimate anchor on the economy. As I undestand it in traditional economic theory, supply could always exist if people were willing to pay more or “substitute.” It seems to me if this EROI theory is correct, the tradtional economic model will eventually break down. You need the very thing you lack (a barrel of oil) to produce the thing you lack: a barrel of oil.

    In summary, I see three phases: Currently, an oil glut which artificially keeps prices low and which has not yet been fully impacted by the borrowing/ debt problem you discuss in this article.

    This glut in supply may be prolonged assuming the economy continues to slow as a result of debt burden.

    But after the economy stabilizes when debt vs demand destruction is played out, the new player will be The EROI

    • Hubbs. You´re well on track, but allow me to point something out: Currently, there´s an oil glut which SHOULD drive prices way lower than they are. Prices are being kept artificially HIGH through the fraudulent futures market, mainly to allow high cost producers to hedge production at an affordable rate and keep pumping to maintain total output volume stable. If prices were allowed to be where inventories say they should, they´d be in the 30´s or even 20´s right now.

      The final consumer cannot allow these prices, unless the money tap reopens for them after ten years of total deprivation, nothing will change. When/if that happens, inflation kicks in again big time. EROI is always the only game in town, the rest is just about how long, how much money, resources, pain and suffering it takes to come to terms with it.

  8. steve,
    shale oil goes down quickly for sure. hwoever, at the end the well often has a longer life production that is 5% of the original. With well “work-overs” , this small flow can be kept alive for quite awhile. This will not help continental, but a small “stripper” company with low debt and low costs may prosper.

    Any positive ideas for energy related investments? Continental looks like a long term short position for me. However, I prefer to play on the long side,

    thanks

    • eddy,

      The situation in the U.S. Energy Sector is going from BAD to WORSE. I mentioned in two of my articles on ExxonMobil that they were likely going to RIGHT OFF a substantial amount of the oil reserves.

      AND GUESS WHAT……. this was published today on Zerohedge:

      Exxon Cuts Reserves By A Record 3.3 Billion Barrels As Oil Crash Finally Takes Toll

      Which means, 20% of ExxonMobil’s oil reserves EVAPORATED overnight…. LOL.

      Looks like THE HILL’S GROUP ETP OIL MODEL is being proven more and more correct as the dominoes continue to fall in the U.S. and Global Oil Industries.

      steve

      • DisappearingCulture | February 23, 2017 at 7:09 am |

        If one takes one of the simpler-to-understand [new reader with no background] articles you or another author has written about energy and post on facebook, there are no are virtually no replies or responses. The equivalent of a blank stare in person.

        I think most Americans would accept a new supernatural concept [Jimmy Hoffa appeared to me in my dream and told me to invest in this stock lol] before they would accept cheap abundant oil is going away forever, and alternativesare not cost or energy [EROI] effective. This includes a cadre of pseudo-intellectual political economists like krugman.

  9. Johny Comelately | February 22, 2017 at 11:04 am |

    I love your work Steve. You are one of the few writers I make a point of reading every new article that comes out.

    I too “finally get” the energy situation when put in the context that we need a minimum of 1/20 EROEI to maintain industrialized economies. We no longer have the surplus energy needed to create aggravate economic growth.

    The transition to an alternative energy system replacement will be rocky. My question is how rocky will it get to transition out of oil? Cliff High believes the government has advanced silver based technologies (hidden beneath the ice in Antarctica) that if released to the public will help us pull out of this.

    I get that it takes existing oil powered manufacturing to build the new technologies. But can the EROI from the new energy sources be so high that it can offset the thermodynamic oil collapse and pull us back up from our boot straps? Even if it costs more money to extract oil, than the value of the oil, a very high EROI from new technology can offset the cost and make the transition feasible. Or can we make a new energy add on device that can fire the pistons of our existing cars without having to rebuild the whole car?

    I guess there’s some wishful thinking on my part. I hope that necessity will be the mother of invention and we can innovate out of this mess!

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