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Smaller E&Ps Squeezed by Debt, Lack of Credit

Two junior exploration and production (E&P) companies last week filed for voluntary bankruptcy protection, and many of the more leveraged explorers may see their companies' misfortunes increasingly tied to slumping natural gas and oil prices, according to energy analysts and credit ratings agencies.

Late Thursday Fitch Ratings reduced its 2009 forecast for U.S. gas prices to $4.25/Mcf at the Henry Hub (see related story). The lower prices through this year will impact the E&P sector, and most especially junior players, said Fitch.

"During the past few years, commodity prices have been significantly above Fitch's long-term expectations, and as a result, most companies faced the choice of growth (generated either via internal projects or acquisitions) versus increased shareholder rewards (higher dividend levels and share repurchases, etc.) as ample cash flows were generated to maintain reserve and production profiles," said the credit ratings analyst. "As prices have moved lower, 'excess' cash flows have dried up, and many energy firms are now in the position where internally generated cash flows are at or below the level of capital expenditures required to maintain existing reserve and production profiles."

Because of the lack of cash flow, Fitch now is forecasting more cuts to capital expenditures for many E&Ps, "with the potential for additional leverage, as most firms may not be able to cut capital expenditure levels fast enough. Both declining production and reserve levels remain a possibility stemming from reduced reinvestment rates and lower commodity price induced reserve revisions."

E&Ps able to establish "high levels of commodity hedges will benefit in the near-term, although they provide limited protections from a protracted downturn in commodity prices," Fitch noted. "Leverage metrics across the sector are expected to rise as borrowings increase to fund negative free cash flows, reserve levels fall due to depletion and reserve revisions, and levels of M&A [merger and acquisition] activity potentially rise once commodity prices stabilize."

Last week Oklahoma City-based Crusader Energy Group Inc. filed for voluntary bankruptcy protection less than a year after launching as a publicly traded independent (see NGI, June 30, 2008). Based on its current financial condition, management determined that "it was in the best interest of the company and all of its stakeholders" to seek bankruptcy protection. Another independent, Saratoga Resources, which operates in the Louisiana offshore, also has filed for voluntary bankruptcy protection.

"Although we have made great progress in increasing our reserves and daily production and are actively pursuing cost reduction efforts to offset the effects of reduced oil and gas prices and assure future compliance with all applicable covenants, the restriction on access to available credit under our revolving debt facility has impaired our ability to continue our development program and to achieve compliance with covenants going forward," Saratoga CEO Thomas Cooke said.

Other E&Ps could follow suit in the coming months if commodity prices don't strengthen or if lending remains tight, said analysts.

Energy analysts with Tudor, Pickering, Holt & Co. LLC noted that E&Ps "inherently want to grow" and are reluctant to shrink, but the credit crunch has forced companies to live within their cash flow. And there's less cash flow now than even a few months ago.

Most U.S. onshore-based E&Ps have "more opportunities than money," which led to a huge uptick in capex, said Tudor's Dan Pickering and Dave Pursell. As 2009 began, many E&P budgets were using $7/Mcf gas prices to set the pace but that was "too bullish," and E&Ps at the time still were "not scared enough."

Tudor analyst David Heikkinen said more mid-size E&Ps could hit a wall as their bank covenants come up for review at lending institutions over the coming months. E&Ps are renegotiating the covenant packages and loans as they can, but some already are being forced to sell equity or assets to pay down the debt. Others will attempt to merge with more cash-worthy rivals.

Last month Calgary-based Suncor Energy Inc. and Petro-Canada announced plans to merge in a C$19.6 billion deal that would create Canada's largest energy company (see NGI, March 30).

"The super majors, particularly Exxon and Shell, can invest through the bottom part of the cycle and are improving their position in Canada," Suncor CEO Rick George said. "We at Suncor had two options...we could kind of pull back" in capital spending, "which we obviously did...or do something that would really strengthen our position and allow us to look at investing and coming out of this cycle stronger than ever." Merging with Petro-Canada "is something that's going to accomplish this," said George.

Suncor and Petro-Canada's merger is big, but more combinations are under way among the smaller players. Denver-based explorer Double Eagle Petroleum Co. last week agreed to buy Petrosearch Energy Corp., based in Houston, in a $9.3 million stock deal to diversify its assets and to provide a financial cushion. And Calgary-based Paramount Energy Trust plans to buy cross-town explorer Profound Energy Inc. in a stock transaction valued around C$113 million.

"This is the kind of deal I think will become more sought after in a low gas price environment," Double Eagle spokesman John Campbell told NGI. "Petrosearch has no debt, and [it has] cash that a rapidly growing company like Double Eagle can use to shore up its balance sheet during this period of low prices..."

Look for more deals -- or more bankruptcies -- in the months ahead, said analysts.

Last Monday New Orleans-based Energy Partners Ltd. said it wouldn't be able to meet a required $38 million payment by Friday, which resulted when its borrowing base was cut to $45 million from $150 million. Without a waiver from the bank, Energy Partners said in a Securities and Exchange Commission (SEC) filing it may file for bankruptcy protection.

Edge Petroleum's credit line was cut, which resulted in a $114 million overdraft, according to an SEC filing. The company worked out an installment agreement to pay the remainder due in May and June. However Edge said in a March SEC filing that its financial commitments have heightened "substantial doubt" that it would be able to continue "as a going concern for a period longer than the current fiscal year."

Moody's Investors Services in late March downgraded Fort Worth, TX-based Quicksilver Resources Inc. to reflect the company's high debt load. Quicksilver borrowed last year to build a bigger stake in the Barnett Shale, Moody's noted.

On Friday Moody's also cut the ratings on Houston independent Swift Energy Co. "The downgrade reflects Swift's deteriorating operating performance, especially its continued high and unsustainable costs trends, and growing financial leverage," Moody's noted. "Specifically, Swift's costs have increased over the past three years,"...and its "leveraged full-cycle cost per barrel has increased 46% year-over-year to $72.23."

In the "upcycle" of the past few years, Swift's capital expenditures (capex) added "considerable debt" without adding a "meaningful addition" to its reserve position, Moody's noted. "Also, over the past three years, Swift's capex has resulted in finding and development costs in the 'Caa' range. Debt/proved developed reserves has increased 9% to $9.79/boe, and debt/average daily production has increased 14% to $21,207."

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