Ensuring capital availability

With that as a backdrop, here are some ways exploration and production companies can prepare for a persistent low price commodities backdrop and the possibility of reduced line availability through the balance of the year.

DO BUSINESS WITH A KNOWN ENERGY LENDER

There are a number of very good banks that have been through the cycles. They have long-standing experience in E&P lending, and these banks don't get skittish at the first sign of a downturn. They structure loans the right way and know how to work with borrowers to ensure capital availability. In turn, this leads to consistent availability for E&P companies who depend on their bank credit facilities for liquidity.

BE PROACTIVE IN INFORMING BANKERS OF PLANS TO WEATHER THE DOWNTURN

If your analysis shows you may be over advanced on your line of credit, or may be up against a covenant limit, be proactive and reach out to your bankers. Don't wait for them to call you.

Meet with your bankers, bring your updated forecasts, and provide details on cost-cutting efforts and plans to reduce capital budgets. Identify other assets that can be pledged to provide additional collateral or sold to pay down outstanding debt.

To date, this is precisely the approach we are seeing from E&P companies. And, by and large, energy banks remain confident today because the industry's reaction to the downturn has been quick, decisive, and meaningful.

TALK TO YOUR INVESTMENT BANKERS

When oil began to slide in November 2014, many assumed the capital markets would be shut for energy companies for the foreseeable future. But this has not proven to be the case. In recent weeks, we've seen a number of energy companies on both the E&P and services side of the equation issue new long-term debt and equity capital at relatively favorable terms in the capital markets.

Energy companies are using proceeds to realign their balance sheets so they can weather the downturn by paying off bank debt and their nearest-term maturity long-term debt. As a commercial lender, you paying off debt isn't always what we benefit from most, but we understand the necessity of planning for the future. Talk to your investment bankers, gather ideas, and consider raising capital while the markets remain open.

HEDGE PRODUCTION

Six months ago, hedging activity at BOK Financial was muted because of "backwardation" of the futures market. E&P companies were loathe to hedge future production at rates lower than the spot market. Playing a little "Monday Morning Quarterback," ask yourself how many energy companies would like to turn back the clock and hedge 2015 and 2016 production at those rates - in the $80 per barrel range - today?

We recommend that E&P companies protect at least a portion of their production as it certainly helps to give your bankers comfort and to protect your line of credit availability. And while it looks like the price of oil has somewhat stabilized, there is always the possibility that some other shock to the system pushes prices lower in the coming months.

KEEP THE LINES OF COMMUNICATION OPEN WITH PRIVATE EQUITY

Over the past year, we've seen a number of private equity firms assemble teams and capital war chests and prepare to purchase assets in the oil and gas sector as they become available.

Valuations might not be what they were six or 12 months ago, but it's definitely worth it to have conversations with private equity firms that are active in the E&P sector and keep them apprised of your progress. No E&P company likes to sell assets at the bottom of a commodities downturn, but in an extreme cash crunch, this source of capital serves as a safety net.

A SPECIAL NOTE FOR ENERGY SERVICES COMPANIES

As energy services are typically the first to feel the pain of a downturn, it's imperative to keep bankers in the loop as you rationalize costs. And it's equally important to be quick at the draw in this regard.

At BOK Financial, we are currently running stress tests on our entire $222 million energy services portfolio assuming a 50% decrease in revenue and EBITDA. Thus far, we've seen service companies take the right action to continue to keep operations cash-flow positive and leverage under control, even in the instance of an extended downturn.

CONCLUSION

There have been six significant downturns in the oil and gas markets just since 2000. In each case, the commodity price fell 50% over a six-month period before returning to a normalized price in the next six months. At BOK Financial, we anticipate that prices will rise by the end of the year. The reduced drilling due to significantly reduced CAPEX budgets should reduce the growth of US supply. The markets should recognize this and lead to prices moving back up. The rig count has steadily come down since November, and as of this writing it is down 50% in the continental US just since the beginning of December.

While it will take time for supply and demand to come back in balance, this bodes well for the future because many of the horizontal wells that were drilled in late 2014 and early 2015 have very steep decline curves. Oil and gas companies have been quick to react and take decisive action in this downturn. That said, the steps outlined above are prudent and worthwhile to take if our collective assumptions are wrong and we are indeed facing an extended downturn of 12 months or more.

ABOUT THE AUTHOR

Mickey Coats is executive vice president and manager of energy lending for BOK Financial. He joined the bank's management training program in 1982 after graduating from Oklahoma State University with a BS degree in mathematics. In 1983, upon completion of the training program, he was placed in the energy department as a commercial lender. In 1999, he was tapped to lead the bank's energy lending efforts and has overseen its expansion and growth beyond its original Oklahoma market to become a major player in the energy industry. Coats is also a member of OGFJ's Editorial Advisory Board.