May 17, 2017 - On Tuesday, the LSTA hosted a CLE presentation by Haynes & Boone, Is There Light at the End of the Tunnel for Oil & Gas Companies? Unlike the last two years which saw one of the deepest dives in the U.S. oil & gas industry, 2017 seems brighter. Oil prices have stabilized at about $50 per barrel and, moreover, oil & gas companies have cut their operating expenses in half permitting profitability at oil prices where they might not have broken even before the recent oil price crash. Further good news is that the crude market is currently in deficit and demand is set to outpace production through the end of 2017. According to the recent Haynes & Boone Borrowing Base Redeterminations Survey, only 24% of respondents anticipate E&P borrowers to see a decrease in their borrowing base redeterminations and substantially fewer respondents see bankruptcy as a likely path for addressing a borrowing base deficiency (as compared to the 2016 surveys). Despite the rosier outlook, it is important to understand how capital intensive this industry is with, according to Deloitte, $3 trillion in capex required over the next five years. If oil averages around $55/bbl, there lies a gap of $750 billion from cash flows to fund capex. In addition to that gap, there is an estimated $400 billion in outstanding debt for the E&P industry at the end of 2016, with $110 billion of that set to mature in the next five years. One of the interesting aspects of financing in this industry are the commodity hedges. Hedge providers typically share in the collateral securing the loan itself on a first lien, pari passu basis. Hedges for any particular transaction should be taken on a case-specific basis with respect to documentation, but one common feature is that hedges benefit from right way risk, where the collateral securing the hedge increase at the same time as a hedge provider’s exposure increases. It is common for lenders to be “watching the store” with respect to protection for hedge providers in that they are often relying only on covenants for the benefit of the lenders rather than separate covenants in the hedge or intercreditor agreement. That being said, for adequate protection, it is important for secured hedges to not be subordinated in the intercreditor agreement. While the outlook has brightened for 2017, many E&P companies were forced into bankruptcy by the dive in oil prices and there have been interesting bankruptcy trends as a result. For one, where Delaware had been the jurisdiction of choice for bankruptcy filings because it is a friendly forum, this last oil patch crisis saw an increase in filings in Texas – 55 filings from 2015 until today. Also, where historically secured lenders had pushed for prompt asset sales when E&P companies filed for bankruptcy to avoid risking their collateral coverage, this was not the case in 2015 and 2016. 27 U.S. E&P bankruptcies ended in Section 363 asset sales, but 31 cases ended in debt-to-equity exchanges. Because of the depth of the fall in oil prices, lenders were not willing to cash out at those low prices. Instead, lenders were willing to support plans of reorganization. One interesting outcome is “unnatural ownership” of some E&P companies by funds and other players. We will see what, if any, consequences this has going forward.
Thank you to Chad Mills, Jeff Nichols, Stephen Pezanosky and Katy Shurin of Haynes & Boone for the presentation.