[Editor's note: A version of this story appears in the January 2019 edition of Oil and Gas Investor. Subscribe to the magazine here.]
When capital markets are challenging and none of the traditional instruments in the financial toolbox look attractive, investors tend to rediscover mezzanine finance. And, after the turmoil throughout world markets in October, the flexibility of mezzanine may make it particularly appealing to investors.
For users, mezzanine capital is not designed to be a permanent source of capital; rather, it is an intermediate financing tool, typically for a specific project. Terms usually consist of an interest-bearing component, coupled with an element of upside for the capital provider. Historically, the latter “equity kicker” has taken the form of warrants, net-profits interest, overriding royalty interest and other instruments.
Funding growth projects can be tough in today’s energy sector, in which E&Ps are at risk of criticism for raising debt above certain levels or for issuing equity to fund capex projects in excess of cash flow. Mezzanine financing’s focus on a particular project means leverage is generally for a limited period, while equity dilution, if incurred, tends to be temporary rather than permanent.