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"There's No More Fat To Be Cut:" Desperate Oil Producers Cut Salaries To Save Mission Critical Jobs

Early last month, Citi “exposed” what it said was shale’s “dirty little secret.” 

In a nutshell, the entire business model is uneconomic and thus the only reason a lot more drillers aren’t bankrupt is because capital markets are still wide open. “Capital markets plugged shale’s ‘funding gap’ from 2009 through the first half of 2015, but they are now tightening, reducing access to liquidity for some producers and shaping their ability to drill,” Citi said, adding that “with eight bankruptcies already announced this year, weaker producers may live or die by the whims of capital providers.”

Well, yes. When free cash flow is negative, you’ve dug yourself a hole (no pun intended) and it has to be filled somehow, so you turn to capital markets. It’s just that simple. 

But when rates are at zero and when the hunt for yield generates a perpetual bid for anything the provides investors with any semblance of income, the market never gets to punish uneconomic business models by putting them out of business. Therefore, these same producers just produce, and produce, and produce some more, driving prices ever lower, rendering their business models even more economic than they already were. What you end up with is a collection of zombie companies desperately trying to stay afloat any way they can.

Of course the perpetually low prices that this dynamic engenders affect the entire space, which is why you’ve seen capex cuts and layoffs even among the industry’s stronger players. Now, it would appear that all of the proverbial fat that can be trimmed, has been trimmed which means that, as WSJ reports, further cost cuts will now have to come from salary cuts because going forward, cutting jobs altogether would imperil companies’ ability to operate.

Here’s more:

As layoffs become the energy industry’s main response to low oil prices, a handful of producers are aiming to trim personnel costs without pink slips by spreading the pain among their employees.

 

Companies including Occidental Petroleum Corp. and Canadian Natural Resources Ltd.are employing hiring freezes, caps on bonuses, and even across-the-board wage cuts to preserve jobs. They and others that already have reduced payrolls—including many drilling and well servicing firms—are reluctant to slash further, say energy-industry experts.

 

In part, they’re trying to avoid the type of skilled worker shortages that followed mass job cuts in prior downturns. But it’s also because their businesses can’t succeed without sufficient staff, especially if the downturn in oil prices reverses course.

 

“There’s no more fat to be cut,” said Deborah Byers, a partner at consultants Ernst & Young in charge of its U.S. oil and gas practice.

 

More than a year after oil prices began their descent to under $50 a barrel from over $100, the number of energy-company layoffs world-wide has topped 200,000, says Graves & Co., a Houston consulting firm. More cuts are expected because crude shows little sign of rebounding soon.

 

Occidental Petroleum has avoided mass layoffs so far. The Houston-based company told its employees last month it will cap bonus payments this year and freeze salaries into early 2016, according to an email reviewed by The Wall Street Journal.

 

Noting that annual cash flow drops by $120 million for every $1 decline in the price of oil, Chief Executive Steve Chazen warned in the email that bonuses “may be further reduced or eliminated” and some jobs could still be cut if oil prices don’t bounce back. In the latest quarter, the company’s cash flow was $1.5 billion, down from $2.1 billion a year earlier. Spokeswoman Melissa Schoeb confirmed the action and said Occidental is “taking aggressive action to ensure the company’s long-term success.”

In other words, these companies are now at the breaking point.

There's a limit to how many people can be fired and how much capex can be cut if you intend to stay in business. Once you bump up against those limits, the only cost cutting option that remains is to gamble that essential employees would rather get paid less and keep their jobs than risk venturing out into an uncertain economy in search of other employment. If you're right, you get to realize a little more in the way of savings.

If you're wrong, and critical employees leave, you're in a tough spot operationally or, as one partner at Deloitte put it, "the undercurrent here—and companies are very careful how they talk about this—is chipping away at the entitlement mentality that has developed over time within the industry."

So for all of the petroleum engineers out there, get ready to make a decision, because it looks like "lower for longer" applies to your salaries just as it applies to crude prices.