April 12, 2016 06:30
Banks Will Squeeze the Oil Patch
While it is the wrong season for “A Christmas Carol,” U.S. energy companies are bracing for words to
that effect from lenders. Redetermination season, a twice yearly ritual when banks reassess credit lines,
is upon us. They are likely to be Scrooge-like. The result: More companies using desperate types of
financing or filing for bankruptcy.
U.S. oil and gas producers depend disproportionately on bank credit to run their businesses. In normal
times redeterminations are a pretty ho-hum affair, but the sharp swoon in commodities 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 many firms. And last fall banks were fairly generous, cutting
borrowing bases by just 11% according to analysts at Raymond James.
Now, despite a 40% bounce since February’s low in crude prices, estimated reductions are 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. A more normal margin of safety is just 80%.
There are two other factors working against indebted energy companies. One is that their hedges are
running out. A barrel fetching $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 issue is that, in their effort to save money, drilling has slowed. That has an impact on how
banks account for proven, undeveloped reserves. If it looks unlikely that oil or gas in the ground will
be extracted then banks can’t count it as collateral for a loan.
Some companies already have 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%.
Furthermore, covenants may 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 in recent weeks as oil prices recovered, vastly outperforming industries such as
finance. That is small solace, though, as the ghost of energy booms past sends a chill through the
industry in coming weeks.
—Spencer Jakab, WSJ, 4/1/2016