Creditors are delaying bankruptcies to avoid owning distressed oil assets

Steven Church and Jeremy Hill April 22, 2020

WILMINGTON, DELEWARE (Bloomberg) --Free oil won’t last. But it may linger long enough to persuade some creditors of bankrupt energy drillers to freeze their court fights awhile so they don’t wind up running a company with a product no one wants to buy.

At least seven North American oilpatch companies have gone bust so far this year, and that was before oil futures started trading at negative prices. This is dimming prospects for creditors who had counted on recovering most or all of their investments. Losses in those cases give energy lenders an incentive to put court fights on hold, or to back delay of bankruptcy in hopes that prices will rebound, just as retailers and landlords declared a time-out when the Covid-19 pandemic closed stores around the world.

“Wherever possible, companies and creditors will take a pause to see how the world and the market develops over the next few months,” said Damian Schaible, co-head of the restructuring group at the law firm Davis Polk & Wardwell. Some of his clients are energy creditors who fought takeover deals they initially made in bankruptcy court after the calculations underpinning the offers were upended by oil’s price collapse.

Creditors must ponder futures trading at negative prices. In recent years companies have negotiated a deal and then filed for Chapter 11 protection, hoping for as short a time as possible in bankruptcy. That may change, said Martin Sosland, a bankruptcy lawyer in Dallas with Butler Snow.

“What you are more likely to see is old-fashioned Chapter 11s,” Sosland said. The company will linger in court to get “a breathing spell to reorganize or sell at a higher price.”

Pausing an energy bankruptcy is riskier than pausing a retail case because of the volatility in commodity prices, said Mark Andrews, who leads Dykema Gossett’s bankruptcy practice group in Dallas. Unlike retail, where a landlord might lose rent for a month and tack it back on later, a creditor or would-be bidder in an energy case risks taking a huge bath if oil prices move the wrong way, he said.

“If you’re in a bankruptcy already, this is a disaster,” Andrews said. “It’s difficult to plan for a bankruptcy where you can’t really forecast to anyone what sort of exit financing might be available.”

As for deals already signed, it’s going to take time to figure out how and if parties can back out, Andrews said. Rules surrounding the levers that allow deals to be called off vary from contract-to-contract, court-to-court and are a topic of debate in the legal world, Andrews said.

Pausing a case can save money by putting a lid on the fees of legal and financial advisers, said Martin Bienenstock, head of the business solutions and bankruptcy group at the law firm Proskauer Rose. Those can cost tens of millions of dollars even for midsized drillers.

In the most recent liquidation case to move forward since the price drop, secured lenders to Alta Mesa Resources will get back just 53% of the $316 million they area owed by the bankrupt driller. Senior noteholders owed $510 million will get back less than 1%. In a court hearing Wednesday, Alta Mesa got court approval to send its liquidation plan to creditors for a vote.

No Letup. Lenders who hold debt backed by oil equipment will be harder to convince because maintenance costs don’t stop, even with a shutdown, Bienenstock said.

“Drilling rigs are like collateral that eats (cows, pigs, chickens, etc.),” Bienenstock said in an email. “It costs money to preserve drilling rigs.”

While the industry waits for prices to recover, distressed-debt investors will be hunting for targets in bankruptcy and targets soon to be there. There’s about $190 billion of distressed energy debt outstanding as of this week, according to Bloomberg calculations, but that paper is cheap for a reason.

“Bankruptcy is no place for amateurs to be playing around, especially on these oil and gas deals,” said Buddy Clark, co-chair of the energy practice at law firm Haynes & Boone. “You’ve got to know what you’re doing.”

Markets for oil to be delivered during the next 12 months are forecasting prices of $20 to $40 a barrel, according to futures data compiled by Bloomberg. That’s “not good enough for marginal producers to make money, even on wells they already drilled,” Clark said. “Smaller companies, more thinly capitalized, heavier debt” are at greater risk of bankruptcy.

For those who can line up the smarts and the logistics, though, there’s money to be made.

“Investors who want to capitalize on this cannot preserve the collateral or operate the business themselves,” Bienenstock said. “They need to hook up with an industry player having the capital and platform to take the collateral, store it, and then use it. So, the best-capitalized industry players, and their investors, can use this as an awesome opportunity to consolidate the industry and profit.”

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