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Energy Lenders Slowly Loosening Grip on Dollars

July 19, 1999
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Energy Lenders Slowly Loosening Grip on Dollars

In the wake of last year's oil bust, energy industry lenders are still keeping a tighter grip on their money. However indications are some banks and investors are starting again to look for places to put capital in the energy patch.

Considering speeches given by banks, mezzanine debt and private capital sources at Gas Daily's Upstream Finance conference last week in Houston, it would seem capital is readily available to producers right now. However, like producers, lenders have been chastened by the recent crisis in oil prices. Tim Murray, senior vice president energy group manager for Wells Fargo Bank, noted trends in the commercial bank market.

Spreads have stabilized, and there is a return to a historical premium for loans to producers, he said. The number of deals is down, and credit structures have been tightened. There is less liquidity in the syndicated loan market and an increased focus on "sensitivity" analyses. Lenders also have placed a renewed focus on current producer cash flow versus borrowing base values.

Murray also predicted what is to come for bank energy lending. Spreads will include an industry premium. As major producers divest themselves of domestic assets the volume of deals will increase. Credit structures will remain tight, and liquidity will improve in the syndicated loan market as new players emerge. There also will be a renewed focus on commodity hedges.

Last year's major oil price decline made public markets tight for smaller producers, noted Robert Zorich, managing director of EnCap Investments. Banks retrenched, and producers found themselves de-leveraging rather than drilling. He predicted major recapitalizations and consolidations will continue. While prices are rebounding, the industry and lenders need time to become "believers."

Formed last year, mezzanine lender Shell Capital has a number of criteria that must be met before it will loan to producers, said Michael Keener, Shell Capital vice president for business development. The company is looking for deals worth $10 million and up, and the more the better. Shell will provide up to 90% of project funding and wants to provide 100% of development capital. "We want to make sure you have the capital. If we're going to go into a project, you're going to have the capital to do the project, so we want to pay for that and get you all that money just be sure it will happen. We don't want economics at a later date to impede the project." Shell also requires producers to hedge. "We want you to hedge, and we will recommend what we think is the right amount of hedging."

Private capital financing comes in when a company has insufficient cash flow to support bank financing, is fully leveraged, has an aversion to recourse debt, or desires more flexibility in debt structure," said Gary Tanner, vice president of private lender EnCap Investments, which was recently acquired by El Paso Energy. Public capital might be unattractive to a company because of an unreceptive market, an unwillingness to become a public company, or the need for quick transaction turnaround.

Private capital lenders take a longer-term outlook than banks and are less reactive to market downturns. Deals can close quickly and there are capabilities for creative structuring. A private capital lender brings energy expertise to a producer as well as market analysis and insight. All this has its price, though. Private lenders want higher returns, and it's possible to lose control of one's company to a private lender.

When producers get in trouble it is usually the result of one or more factors, said Bart Schouest, managing director with Banque Paribas. Putting a producer's back to the wall can be declining prices, poor drilling/development results, problems with cost control and capital structure challenges. When a company finds itself in trouble, action must be taken. Bankers aren't satisfied to wait around for prices to improve, Schouest cautioned. Steps to take include the development of a comprehensive restructuring plan with reasonable expectations. Borrowers should be prepared to restructure bank debt. Among other actions, a non-core divestiture program should be outlined; commodity hedging should be evaluated; operating costs should be cut and production maintained.

Joe Fisher, Houston

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