THE BORROWING BASE determination process is complex. The comprehensive assessment that precedes the redetermination takes several factors into consideration. And while the nuts and bolts of the process are out of my wheelhouse, it made sense to me that-given the low and lingering oil price-fall redeterminations would be tough on many following a fairly uneventful redetermination cycle in April. I wasn't alone.
In September, Haynes and Boone LLP conducted a survey of 182 executives from financial institutions, private equity firms, independent producers, and professional services providers to gain a sense of what lenders, borrowers, and others expected regarding fall redeterminations. Respondents said they expected 79% of borrowers to see a decrease in borrowing bases this fall with an average expected decrease of 39%.
In an early October report on the North American independent E&P sector, Moody's Investors Service noted that low oil and gas prices "will weaken the liquidity of many lower-rated North American exploration and production companies after creditors redetermine their reserve-based lending facilities' borrowing bases in the fourth quarter of 2015."
In a recent article for OGFJ, Skadden attorneys set the stage similarly: "The fall redeterminations come at a time when the highly-leveraged oil and gas industry faces a high degree of uncertainty and varying levels of distress, driven largely by continued low commodity price levels," they said. Add to that the hedges that roll of at the end of 2015 and into 2016 and the pressure felt by US banks from regulators to reduce exposure to the industry, and you have what many believe "could be a pivotal driver of a punitive fall redetermination season across the industry."
Low oil prices have marred companies in myriad ways; however, recent fall redeterminations have been, as Jefferies energy analysts described in an October 19 note, "surprisingly gentle."
Here, a quick sampling of redeterminations sourced from company filings as of that date: Memorial Resource, Gulfport Energy, RSP Permian, and Callon Petroleum saw their borrowing bases increase. Chesapeake Energy, Cabot Oil & Gas, Range Resources, Kosmos Energy, Ultra Petroleum, PDC Energy, Bill Barrett Corp., Rex Energy, Gastar Exploration, Abraxas Petroleum, and Comstock Resources had borrowing bases maintained.
Hanwen Chang, a corporate development associate at Nexen and author of an October OGFJ article on fall redeterminations, told me as I wrote this column that about 35% of high-yield companies had reported borrowing base results from the fall redetermination cycle that started in July.
"The average borrowing base change has been -2%, with 10% unchanged, 7% borrowing base increases averaging +25% and the 20% decreasing on average 15%. However, 50% of companies saw no change to their liquidity as companies who experienced borrowing base declines had lender commitments below the borrowing base."
Going back to the October 19 Jefferies report and looking at the 25 companies tracked by the firm that disclosed fall loan redeterminations, the aggregate borrowing base capacity fell only about 2%.
Thus far, results seem to fall in line with recent Wood Mackenzie reports claiming exaggerated concerns surrounding October reserves-based-lending redeterminations (Read more in Upstream News, p. 14). In one report, in examining the financial health of the top 26 US independents, WoodMac determined that the larger producers, along with the majors, "have the required flexibility to tide them through the near term at the very least."
As explained by Fraser McKay, Corporate Analysis Research Director for Wood Mackenzie, "Most companies in the peer group have rising absolute debt levels, and October's RBL redeterminations have been latched onto as a potential catalyst for sector implosion. But at least two thirds of Lower 48 production is attributable to companies with no RBL exposure at all, or have no redeterminations until 2016." Of those that do, "most can accommodate a borrowing base cut of over 50% before their situation becomes imminently critical," WoodMac continued. In a separate analysis, the firm looked at the then-upcoming borrowing base redeterminations for 17 high-yield operators. The bottom line, they said, is that "far fewer companies will struggle with liquidity after the October borrowing base redeterminations, contrary to current popular belief and speculation."
Does that mean that borrowing base declines didn't and won't occur? No. Does it mean that the road ahead is a smooth one? No. But the fall redeterminations aren't the end of the road.
For now, noted Jefferies, banks appear to be supporting producers and liquidity has remained stable for a few reasons. First, "producers have provided banks with additional collateral," creating a larger 'mortgage' pool; "PDP reserves have risen in 2015 amid high development budgets (largely funded by early-year equity raises)," and finally, "banks have clearly chosen to support many customers by setting aside more capital against riskier oil and gas loans but while also adding new/modified 'restrictive covenants' for future protection," the analysts detailed.
The end of the fall redetermination cycle is near. What happens between this writing and December is unknown, but the fall redetermination cycle isn't the end for most US independents. Banks appear to be giving producers more time to get financial houses in order...until Spring 2016 redeterminations, which, assuming a little improved price environment, could be much less forgiving.