Energy issues

One would not think that famed American poet Robert Frost would, in the 1950s, have the understanding and foresight to predict the condition of energy funding sources in 2016. But he did, noting that “a bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain.” Well said, Mr. Frost. Until a year or two ago, access to capital—to finance shale development and, to a lesser extent, deepwater development—from lending institutions was fairly easy. The vast majority of these loans were secured by, and based on the value of, the oil and gas reserves owned by the producer. The fall of oil and gas prices has resulted, according to analysts at AlixPartners (The shift to equity: Is there a return to historical norms?), in redetermination of the value of the reserves held as collateral. This twice-yearly redetermination process has led, says the group, to “a wave of in-court and out-of-court restructurings.” More specifically, the analysts found that:

• “More than 75% of the companies reviewed—43 producers—experienced redetermination declines, with borrowing bases dropping an average of 28%.
• About 21% of the companies reviewed—12 producers—saw their borrowing bases remain unchanged.
• Two businesses saw an increase in their borrowing bases because of acquisitions of high-quality assets.”

All this is occurring as the targets for oil and gas acquisitions are also changing. A recent article by Bloomberg (Shale land grab tops mergers as buyers await better oil outlook) concludes that M&A activity has slacked off and is being replaced increasingly by land purchases. As Bloomberg notes, “handshakes between U.S. oil and gas explorers have had more to do with acquisitions of coveted acreage in the Permian basin, straddling West Texas and New Mexico, or Oklahoma’s SCOOP and STACK areas, than agreements to share a head office and logo.”

According to Bloomberg, “of the $32.1 billion in deals U.S. oil and gas explorers signed this year (as of late August), 52% were asset sales, mostly land in the country’s hottest plays … but even in the case of deals that are tallied as takeovers, often it’s the acreage that comes along with the acquisition that drives the buy.

But the game is changing in other ways, too. To help pay for the bargains, producers have issued a record $20.59 billion in shares so far this year.” According to AlixPartners, operators, and the service and supply industries, are on track to issue some $30 billion in equity capital during 2016. That’s 500% more than 2014, and more than is projected to be raised by bonds and private placements.

Access to capital in today’s down market also varies by the size, and focus, of the operator. A recent EY study (Funding challenges in the oil and gas sector: Innovative financing solutions for oil and gas companies), offers a good analysis of the capital acquisition options open to various types of oil and gas companies. These include:

• Small-cap explorers. As would be expected, “equity capital market conditions for most small exploration companies remain difficult … companies without cash flows from operations, lacking in scale or with risk concentrated in a single project or country are likely to face a more challenging funding outlook,” according to EY. “Equity issuance is often the first or only option for pure-play exploration companies, which lack tangible assets, but offer material upside in the event of exploration success.”
• Mid-to-large-cap operators. The largest users of reserve-based lending are larger independents. However, notes EY, the current down cycle, and less restricted nature of alternative funding, are driving these companies away from bank markets toward more non-traditional funding. For larger independents, the issuance of bonds is becoming the preferred funding mechanism, due to fewer continuing obligations than bank loans.
• International oil companies (IOC). Until the fall in oil and gas prices, much of the capital funding for international oil companies was derived from massive operating cash flows they generated, according to EY. In order to bridge the gap between former cash flow and current cash flow, international oil companies are “both divesting non-core assets to release capital that can be recycled into higher return areas of the business, and seeking to de-capitalize parts of the business that struggle to compete for internal capital allocation,” says EY.
• National oil companies (NOC). NOCs are often larger spenders than their IOC counterparts. These companies have been increasingly active in the international debt markets. According to EY, “NOCs took advantage of the rally in emerging bond markets in the last couple of years, as international investors sought exposure to higher growth in Asian markets. CNPC and Petrobras were responsible for the two largest bond issuances in the sector in 2013.” A second increasingly popular option is prepayment transactions, wherein lending institutions “prepay” for future supply from a portfolio of producing assets.

And then there is the giant—Saudi Aramco. An initial public offering (IPO) of stock now looks likely, although, according to Energy, Industry and Mineral Resources Minister Khalid Al-Falih, the IPO depends on oil and stock market conditions. According to the August 29 edition of Arab News, the IPO would offer some 5% of Aramco shares before the end of 2018, raising an estimated $2 trillion to $3 trillion.

In conclusion, according to comedian Bob Hope, “a bank is a place that will lend you money if you can prove that you don’t need it.” 

About the Authors

William J. Pike

World Oil

William J. Pike has 47 years’ experience in the upstream oil and gas industry, and serves as Chairman of the World Oil Editorial Advisory Board.