June will likely be the biggest month in the history of Xcite Energy  (LSE: XEL). The company has to pay back $135m to bondholders on the 30 June and with only $14m cash in the bank it looks unlikely to be able to do so. Gulf Keystone (LSE: GKP) is in a similar position and has entered a standstill agreement with bondholders due to lack of funds for interest payments. 

Toxic debt levels

Debt is a powerful tool for oil and gas companies to fund large developments. The problem is, if the oil price falls then cashflow is hit and debt repayment stalls. This is where Xcite and Gulf Keystone have struggled. Both have high levels of debt and without large refinancing both may default. Xcite has $135m of bonds due for repayment this month, impossible at the moment as cash balances are below $15m. This means Xcite need a refinancing package to pay the debt off and finance the heavy oil Bentley development. Gulf Keystone is in a similar position, the company can’t meet interest payments on its $575m of bonds and is now in discussions with bondholders. The company owns the giant Shaikan field in Kurdistan but due to instability in the region, isn’t being paid in full for its crude, which has led to lower than expected cashflow. 

Equity wipeout

As both of these businesses have huge debt levels it’s likely current equity holders will be wiped out. Bondholders may take control of the company through a debt-for-equity swap or a similar type of deal. There could be an equity-for-debt swap and rights issue like the refinancing package gold producer Petropavlosk carried out last year. There could be an even worse scenario for shareholders, as at Petroceltic, the London-listed oil company that has been taken over by bondholders and shareholders have lost almost everything. Gulf Keystone and Xcite could easily go this way to so keep an eye out for bondholders playing hardball with the company. 

Will either survive?

Xcite Energy looks unlikely to survive in my view. In the current oil environment the company is unlikely to get a financing package for a heavy oil field in the North Sea. The shares are a complete sell and I would avoid them at all costs. Gulf Keystone is also a stock to avoid. Bondholders are likely to take control of the company and investors hoping for a takeover will be disappointed. These two companies aren’t the only two in trouble at the moment either. Circle Oil and LGO Energy are two others with high debt levels and little chance of survival.

Picking suitable oil and gas companies for investment is extremely hard but can obviously create huge returns for investors. For example Gulf Keystone’s share price went from 6p in 2009 to 411p in 2012 and back down to the current 4p. That shows the dangers as well as the reward of investing in oil and gas stocks. There are lots of good companies out there but Xcite and Gulf Keystone are definitely two to avoid. 

A few years ago Xcite and Gulf Keystone both had huge potential but as we've seen, neither lived up to it. The increased level of risk with growth stocks must be carefully analysed to avoid losing all your investment. 

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Jack Dingwall has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.