Oil and gas producers are expecting an improved outlook for the energy industry and plan to ramp up their borrowing bases in the future, according to a survey conducted by law firm Haynes and Boone.
In its recent poll, 78% of the oil and gas producers said they plan to increase their borrowing bases while 36% of companies said they predict their borrowing bases to rise by 20% or greater. This rate of optimism is on par with the law firm’s spring 2018 survey.
The loans that E&P producers obtain are assessed by their lenders twice a year to determine the amount of credit that will be available based upon the collateral value of the producers’ property. These borrowing bases affect the projections from banks about future prices for the producers’ oil and gas reserves.
Haynes and Boone began conducting the survey in April 2015 about the projected financial state of the domestic energy market. The law firm polls the oil and gas producers, oilfield services companies, energy lenders, private equity firms and other industry participants twice every year in order to obtain their predictions about producers’ future borrowing capacity.
The oil and gas industry is now displaying “alot of optimism” compared to the downturn which occurred four years ago when crude oil prices fell, said Kraig Grahmann, partner in the energy, power and natural resources practice group, Haynes and Boone.
“The drop in oil prices led to years of the energy industry being in a downturn,” he said. “It was a slow recovery, but in the past 18 months, the sector has sustained a recovery and is starting to pick up.”
The rise of oil prices is one factor which is contributing to E&P producers demonstrating a more positive outlook.
“In late 2014, we were told we would never see prices at these levels again,” he said. “The U.S. oil and gas industry has proved to be more resilient than anyone expected.”
The high level of production of oil from the U.S. has influenced OPEC’s strategy.
Another contributing factor to how oil and gas companies perceive the future is that many companies have improved their balance sheets drastically.
Many energy companies took on “a lot of debt” to pursue other opportunities between 2010 to 2014, but that strategy proved to be unsustainable, said Grahmann. A large number of the companies were forced to restructure their debt and filed bankruptcies.
During the past one to three years, these companies now display healthier balance sheets and are not as levered up, he said.
“These energy and exploration companies now have a better ability to function, operate and perform well,” Grahmann said.
After the energy industry’s downturn and the pain that the companies experienced, many of the executives are likely being more prudent now in their decisions on accruing debt, he said.
“Often after a downturn, the mistakes that caused it are repeated because people may still think that this time oil prices are higher so it’s different and we won’t have same downturn - this is possible when companies are over levered and there is a sudden shock in commodity prices,” Grahmann said.
In the near term, energy companies are not likely to encounter this scenario even though being overextended is a possibility since acquiring oil and gas properties is very expensive.
“It takes a lot of money to make acquisitions and complete the drilling of a well,” he said.
Debt remains an easy source of capital for energy producers to obtain compared to other options.
“It’s very attractive to companies to take on debt if you have a positive view of where commodity prices are headed,” Grahmann said.
The outlook has improved dramatically in the past 12 months driven by sustained higher prices for crude oil and continued positive revisions for demand, said Patrick Morris, CEO of NY-based HAGIN Investment Management.
“The market is still worried about a possible oversupply, so we will likely see some hesitation within the lending community to underwrite new paper, but existing credit facilities should expand to meet the higher reserve valuations,” he said.
Increased borrowing capacity for E&P companies is the siren song that should be avoided, said Ethan Bellamy, a managing director who covers energy stocks at Baird, a Milwaukee-based investment bank. Investors should refrain from the companies who accrue a large amount of debt.
“Investors want producers to avoid consuming more capital and instead live within cash flow,” he said. “The test will be if they can maintain discipline in the face of the increasing value of the collateral they have on offer for banks.”
The Haynes and Boone survey portrays how healthy the upstream participants generally are, said Marshall Lynn Bass, managing director of Silverstone Energy Partners, a Houston-based fund which invests in U.S. energy and production projects and companies.
“This in not because of irrational exuberance on the banks part as energy and exploration producers on the whole have been achieving financially responsible growth and banks are naturally and prudently increasing borrowing bases,” he said. “It also highlights the fact that U.S. E&P’s have world-competitive projects.”
Energy companies could run into a hurdle because the trade war has increased steel prices and was not a commodity many executives had factored into their budgets that would rise, Grahmann said.
“When you’re drilling oil, they need a steel,” he said. “This cost is not a game changer.”
While midstream companies and refiners will be impacted most by the trade tariffs, the entire industry, including upstream companies will be paying more for the materials they are utilizing.
“They will notice it in their pocketbooks,” Grahmann said.
Midstream capacity constraints remain the largest challenge next year because after the downturn, these companies did not want to build a lot of infrastructure, gathering systems and pipelines.
“It will take longer for midstream companies to ramp up and meet the needs of E&P producers,” he said. “There is a lot of work in progress, but the midstream companies still need to catch up.”
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