Michael T. Slocum
Upstream Technology Editor
For the majority of US small and midsized exploration and production companies, credit secured by liens on their assets represents the best way to get debt capital, according to industry analysts at Raymond James Financial Inc. Loans are backed by reserves valued by oil prices. As prices fall, collateral value falls as well.
In April, lenders conducted the first of two annual oil and gas loan reassessments known as redeterminations of borrowing base. Expectations were that companies could offset the already precipitous drop in oil prices by demonstrating production growth, extending hedge positions into 2016, or by pledging additional collateral to lenders.
With April oil prices at about $50/bbl and predictions of a third-quarter recovery, April redeterminations were uneventful, with only nominal changes made to oil and gas companies' borrowing base.
Prices continued to fall. OPEC's adherence to its market-share strategy, the possibility of Iranian barrels coming on the market before the end of the year, and the devaluation of China's currency, make a recovery this year seem like a long shot.
The next round of redeterminations is in October and could be much more painful as the problems the industry faced in April have compounded.
Critical issue is debt
In March, David Fessler, energy and infrastructure strategist for the Oxford Club, compiled the "Oil Company Death List" to highlight oil and gas companies that have become extremely overleveraged as oil prices have fallen. Massive debt is the critical issue. Some of the companies on Fessler's list have already defaulted on their loans. But the problem is far wider than the companies he named.
According to the Bank for International Settlements, the global oil and gas sector's total debt is $2.5 trillion, more than twice what it was 10 years ago. The decline in the value of assets backing up that debt is increasing pressure on banks to slash credit lines, request a payback, or even call in debts.
Since April, the outlook for an oil-price recovery has become more guarded. In a June speech to the Heavy Oil Conference in Calgary, Society of Petroleum Engineers Pres. Janeen Judah spoke of the similarities between this downturn and the 1980's, when supply outpaced demand and depressed prices for more than a decade.
Wunderlich Securities Inc. said this sentiment is becoming increasingly prevalent. This month, it reported that some producers have commented on the possibility of oil prices not rebounding until 2018, when the oil and gas market is projected to balance.
A buyer's market
Wunderlich believes October's redeterminations will affect activity levels. With hedges rolling off, slimmer borrowing bases could constrain liquidity and 2016 capital expenditures, leading to lower production.
The fallout from a particularly tough round of redeterminations ranges from capital expenditure reductions, to asset sales, to increased mergers and acquisitions. This is especially true for smaller US independent oil companies in unconventional plays where cost of production makes it difficult to have cash reserves in this price environment. Servicing debt becomes an issue and hard decisions have to be made.
According to a second quarter Ryder Scott report, weaker, leveraged companies will need to liquidate creating a buyer's market later this year. Wunderlich believes there will be an appetite to increase acreage holdings from larger public exploration and production companies and that mergers and acquisitions will be a major theme in the coming months as weak companies exit the market and the strong survive.
The inactivity of the first three quarters of 2015 could be replaced by a flurry of activity after the October redeterminations. Raymond James believes that the proactive moves that protected companies in April, such as hedging, won't be as successful a second time around.
