While it is the wrong season for “A Christmas Carol,” U.S. oil and gas producers are bracing for words to that effect from their lenders. Redetermination season, a twice-yearly ritual in which banks reassess credit lines, is once again upon us, and they are likely to be Scrooge-like. The result could be that more companies are forced into financially desperate types of financing or bankruptcy filings.
U.S. oil and gas producers depend disproportionately on bank credit lines to run their businesses. In normal times the seesaw of commodity prices makes redeterminations a pretty ho-hum affair, but the sharp swoon since mid-2014 is spooking banks. Even so, last spring’s redetermination came after a brief rebound in prices and successful stock and bond issues by several firms. And last fall banks were relatively generous, cutting borrowing bases by just 11% according to analysts at Raymond James.
Now, despite a 40% bounce since the February low in crude prices, the estimated reductions are a lot sharper—some 20% to 30% on average. Part of that is because banks have been lenient. For example, Raymond James thinks banks valued the “strip”—all the futures prices for oil or natural gas—at 87% to 95% of what they fetched on markets. That seems conservative but a more normal margin of safety is just 80%.
Eve aside from that, there are two other factors working against indebted energy companies. One is that their price hedges are running out. A barrel sold for $38 but effectively sold for $70 because its price was locked in with derivatives such as swaps can be valued at that higher price. But prices have been low for long enough that few companies have much of their production covered.
Another problem is that, in their effort to save money, drilling has slowed down. That has an impact on proven, undeveloped reserves. If it looks unlikely that oil or gas in the ground will ever be extracted then banks can’t count it as collateral for a loan.
Some companies have already delivered the bad news. WPX Energy said it had a 30% reduction in its borrowing base and Whiting Petroleum estimated that its base would be cut by 38%. Beyond these numbers, covenants on loans are likely to become more serious and “antihoarding clauses” introduced. These prevent financially troubled companies from drawing down unused credit lines just to have the cash on their balance sheets.
The irony in redeterminations is that, despite the negative tone, energy companies’ high-yield bonds have rallied. So far this year they are 88 basis points lower compared with a rise of over 40 percentage points for technology and financial firms.
That is small solace, though, as the ghost of energy booms past sends a chill through the industry in coming weeks.
By Spencer Jakab
Source: Wall Street Journal
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