Lenders to the oil and gas industry have been extraordinarily lenient amid the worst downturn in decades, allowing indebted companies to survive a little while longer in hopes of a rebound in oil prices. But the screws are set to tighten just a bit more as the periodic credit redetermination period finishes up.
Banks reassess their credit lines to oil and gas firms twice a year, once in the spring and once in the fall. While the lending arrangements vary from bank to bank and from borrower to borrower, lenders largely punted on both redetermination periods last year, providing a grace period for drillers to wait out the bust in prices. But oil prices have not rebounded much since the original crash in late 2014.
Time could run out for companies that have been hanging on by a thread.
For much of the past decade, Crispin Odey has been waiting for inflation to rear its ugly head. The fund manager has been positioned to take advantage of rising prices in his flagship hedge fund, the Odey European Fund, and has been trying to warn his investors about the risks of inflation through his annual Read More
Debt was not seen as a big problem in the past, as triple-digit oil prices had both lenders and borrowers eager to see drilling accelerate and spread to new frontiers. Indeed, debt rose even when oil prices exceeded $100 per barrel. According to The Wall Street Journal, the net debt of publically-listed global oil and gas companies grew threefold over the past decade, hitting a high of $549 billion last year. In fact, debt accumulated in the sector at a faster rate between 2012 and 2015 – a period when oil prices were exceptionally high – than in previous years.
With oil prices down more than 60 percent from the 2014 peak, piling on ever more debt to a loss-making operation looks increasingly untenable. Distressed energy loans – loans in danger of default – account for more than half of the energy portfolio at several major banks.
“When oil was at $100 a barrel, debt was easy to get,” Simon Thomson, CEO of Cairn Energy, told the WSJ in an interview. “What we’re seeing today is a number of people suffering the hangover of having secured that debt and now possibly having trouble servicing it.”
About 51 oil and gas companies from North America have filed for bankruptcy since early 2015, but there are 175 more that are in danger of not being able to meet debt payments. For context, 62 oil and gas companies fell into bankruptcy during the financial crisis in 2008 and 2009.
Companies struggling with debt payments and shrinking revenue could see the taps shut off or at least reduced. Some analysts see cuts to credit lines on the order of 20 to 30 percent.
Whiting Petroleum, for instance, announced in early March that its credit line would be slashed by more than $1 billion, a reduction that could be one of the industry’s largest. Whiting had a $2.7 billion loan revolver at the end of 2015, and the company’s CEO expects to have “at least $1.5 billion” left after this spring redetermination.
Regulators are also pressing banks for more scrutiny, and lenders are increasingly using the metric of classifying loans to companies with debt exceeding four times EBITDA as “substandard” or lower. According to Oil & Gas 360, banks are moving loans with a debt-to-EBITDA ratio exceeding 4x to their workout units.
“This has the makings of a gigantic funding crisis,” the head of Deloitte’s restructuring department, William Snyder, told the WSJ.
Oil & Gas 360 says that banks are also marketing their troubled debt to hedge funds, marking down distressed debt to cents on the dollars. Hedge funds could buy up discounted debt in hopes of repayment.
Meanwhile, although the credit markets are squeezing drillers, equity markets remain open, at least to some. Reuters reported last week that about 15 companies have announced new equity offerings in 2016, and most have not been adversely impacted. Most of the 15 companies issuing new stock have performed better than an oil and gas producer index by about 3 percent on average. Of course, only relatively strong firms have decided that the equity markets would be open to them. Around $10 billion in fresh equity has been issued so far this year.
The credit redeterminations are currently wrapping up and the details of many of them could soon be released. The deeper banks cut their credit facilities, the more likely struggling oil and gas companies could be forced into bankruptcy.
By Nick Cunningham of Oilprice.com