The pain for U.S. exploration and production (E&P) companies may not be over as commercial banks begin their spring borrowing base redeterminations, which have the potential to reduce debt limits and begin a wave of restructuring, analysts with Raymond James & Associates said Monday.
Analysts Kevin Smith and J. Marshall Adkins did a deep dive into the "mechanics" of their covered E&Ps to consider which ones, if any may face consequences from declining lending levels. What they found is that the determinations in the next two months or so could lead to a 15-20% reduction in overall E&P bank credit facilities.
"All things equal, a lower price deck would result in borrowing bases declining by roughly 30%" from last fall's redeterminations, wrote Smith and Adkins in this week's Energy Stat. Bank redeterminations are made twice a year, in the spring and again in the fall.
The average price banks may lend against could "decline by 28% on the oil side and roughly 18% for natural gas this spring," the analysts said.
For most small/mid-cap E&Ps, lines of credits from banks are the primary way to access debt capital. The credit lines, used to fund working capital and drilling expenditures, typically are secured by liens on individual oil and gas properties. Borrowing bases are determined from the value of the reserve base, found by multiplying the volumes in proved developed producing properties by an assumed price deck.
Bank redeterminations usually aren't a cause of concern, but with the sharp pullback in crude oil prices, they are a big deal this year, said the Raymond James analysts. "Layer in the fact that the high-yield markets are effectively closed off, and E&P operators are even more reliant on commercial banks for near-term liquidity financing."
Standard & Poor's Ratings Services in January had said prescient planning by some U.S. explorers should enable many to keep their heads above water this year, but if oil prices didn't rebound by 2016, liquidity issues could surface (see Shale Daily, Jan. 22).
Based on the Raymond James review, however, bank lender price decks could drop by more than 20% during the spring redetermination, impacting some less-prepared E&Ps.
"Based on prices alone, we estimate that borrowing bases would decrease by roughly 30% on average as a result," said Smith and Adkins. Positive impacts from production growth in the last half of 2014 and restructured hedge books, could "offset some of the pain" during the spring redetermination. U.S. production growth from unconventional reserves "should lead to increased levels of proved reserves, acting to boost borrowing bases."
Companies most affected by the upcoming redeterminations already had in place "poor hedges, declining production and high current borrowing base utilization," according to Raymond James. However, the fall redeterminations could be worse.
Some E&Ps "will need to make moves before fall. For the majority of small and mid-cap E&P companies, credit facilities secured by liens on individual oil and gas properties represent their primary vehicle to access debt capital..."
In the real world, commercial banks don't want to take over E&Ps. To ensure their borrowing bases don't fall by 30% or so, there are proactive steps to take, according to analysts.
Proactive factors that likely would allow E&Ps to counteract possible debt reductions include demonstrating production growth, which should increase PDP reserves, thereby offsetting some price-related declines. Some management teams also are restructuring their hedge books, which takes gains from 2015 hedges and redeploys them into lower priced 2015/2016 hedges.
"If done properly, this is a cashless transaction that lowers near-term revenue but extends hedge value further into the future," noted Raymond James. Because banks usually roll off the first six months of cash flow, companies that have most of their hedging gains in the first six months of 2015 receive no borrowing base credit for those mark-to-market gains.
"Considering the move in oil prices over the last six months, many oil hedges are currently deeply in the money. Therefore, we expect to see a lot of hedge books restructured in this fashion as firms act to smooth out their hedging gains over several years."
Another tool companies could use to offset the effect of lower price decks is pledging additional collateral. "In this case, even though the fully confirming borrowing base amount might be reduced, the commitment level could theoretically stay the same."
If oil and gas prices remain low, fall redeterminations are going to be much more painful, the analysts said.
"The problem starts to compound when you factor in domestic oil production will likely decline as drastic cuts in capital spending start to take effect; and the companies who were saved by hedges this time around will have had another six months of hedging value roll off the books, resulting in a greater percentage of production getting valued off of the bank's price deck."