US producers to see more credit tightening

US oil and gas producers will continue to see their ability to borrow money restricted further this year as banks tighten their purse strings, according to a series of surveys by law firm Haynes and Boone.

Twice per year lenders assess oil companies' capacity to take on debt, known as the borrowing base, by calculating the value of their reserves based on prevailing crude and natural gas prices. When this borrowing-base redetermination was last conducted in the spring many companies saw their access to capital cut, which helped spur on a steady stream of bankruptcies. Already this year 40 North American exploration and production companies have filed for bankruptcy protection, including 17 in the third quarter.

Of the 142 lenders, producers, and other companies Haynes and Boone surveyed, the majority of them — nearly 75pc — expect borrowing bases to fall by 10-20pc this fall. The figures represent a slight improvement from the spring when most respondents said they anticipated a decline of at least 20pc.

But the situation continues to look grim for the industry.

"Despite this improvement, many producers have limited availability under their borrowing bases and thus are not in a position to absorb even a minimal decrease," said Kraig Grahmann, head of Haynes and Boone's energy finance practice group.

According to the law firm's survey of banks for the oil and gas prices they use to calculate a producer's borrowing base, the average base case for oil is $36.50/bl this fall compared to $32.03/bl in the spring. In 2021 the average base case for oil rises to $39.27/bl versus the $37.40/bl calculation the banks had made for 2021 earlier this year.

Producers appear to be well-hedged this fall, according to the survey, but most of uptick in hedging was likely done recently when the prices were not particularly attractive to producers.

But price is just one factor banks use to determine borrowing bases, as companies still expect them to drop nearly 16pc from last spring despite the higher crude prices. Banks are now more wary of risk as both the oil and gas industry and the wider economy continue to struggle. Banks may now make changes in how they evaluate producers reserves, including only giving them credit for wells that are already online and generating cashflow, disregarding proven but undeveloped (PUD) reserves.

"This means that producers will not see any value for prospective wells, but rather only credit for wells currently producing cash flow that can repay their loans," the survey said.

Faced with such a tight lending environment, producers are increasingly self-funding their operations from existing cash flow or using financial transactions like voluntary production payments (VPP), which enables a producer to borrow against a specific quota of oil and natural gas produced each month. Texas oil producer Callon Petroleum entered into a transaction similar to a VPP this month when it sold a 2pc share of its revenue interest for all of its oil and natural gas production to a private equity firm for $140mn.

Producers are also turning to other non-traditional sources of capital. According to Haynes and Boone, 13 percent of producers plan to ask "alternative capital providers" for money, the fourth largest source of capital in the survey behind cash flow, bank debt, and monetary transactions. Such lenders though charge higher interest rates for their loans.

Another 18 percent of producers say they will ask private equity firms for money or form joint ventures with them.

A number of companies have already revealed the outcomes of their borrowing base redeterminations, including deepwater producer Kosmos Energy, which said this week it's capacity was lowered by $130mn to $1.32bn. Also this week Permian basin-focused producer Centennial Resource Development said its borrowing base was reaffirmed at $700mn.

Over the longer term, 82 percent of respondents to the Haynes and Boone survey say they expect the traditional system of finance to survive. But they also expect lenders to tighten terms, including higher interest payments and cash flow sweeps, in which banks automatically take excess cash flow from a borrower's accounts to pay down debt.

By Thomas Lee