U.S. energy producers face the threat that banks will slash their credit as March's crash in oil prices means the asset backing their main loan facility—crude reserves—is worth less than half of what it was a month ago.
The oil price collapse has crushed U.S. energy companies, sending valuations spiraling and squeezing financing options, as they face a likely 20% drop in worldwide oil demand in coming quarters due to the coronavirus pandemic.
U.S. crude prices have dropped to about $20 a barrel as the number of virus cases exploded worldwide and destroyed demand while top producers Saudi Arabia and Russia ended an alliance to curb supply—and promptly started ramping up production to maximum capacity.
For the shale industry, the twin supply-and-demand shocks could not come at a worse time. The industry's key financing tool—loans backed by proven oil and gas reserves—is facing a semi-annual pricing review. Banks use U.S. crude prices to evaluate reserves, and with oil falling from $61 a barrel on Jan. 1, those institutions could cut borrowing lines by anywhere from 25% to 50%, according to interviews with more than a dozen industry and financial sources.
"I think it is fair to say that U.S. shale is about to confront the biggest liquidity crunch in its history," said Shaia Hosseinzadeh, managing partner at investment firm OnyxPoint Global Management, who estimated the reserve-based loan (RBL) market to be worth more than $200 billion.
The correlation between falling oil prices and smaller loan size is not exact. A company's resources fluctuate as it discovers and extracts oil, reshaping the collateral behind the loan, while different banks providing funds have alternative values for crude, which adjusts the calculation.
Around a third of all publicly listed U.S. oil and gas producers could need a debt restructuring or to file for Chapter 11 bankruptcy protection this year, with RBL non-compliance the likely trigger for many, according to forecasts from financial and legal advisers who spoke to Reuters on condition of anonymity to discuss sensitive matters.
If U.S. crude averages $30 a barrel in 2020, more than half of the 30 U.S. producers tracked by Raymond James would have a net debt-to-EBITDA ratio of 3 or more, it said March 26. That level is traditionally considered where companies are in a stressed leverage situation.
For financially stretched energy companies, a smaller RBL is akin to slashing an overdraft line when it is being used to pay everyday bills.
Financing opportunities outside of this loan facility, including equity and debt sales, have already dried up as investors have long turned their backs on U.S. oil-and-gas companies after record production volumes failed to translate into profits for Wall Street.
Lenders to the oil and gas industry were already showing signs of caution during the last RBL review in the fall, with major banks such as JPMorgan Chase and Wells Fargo cutting their estimated values for oil-and-gas companies' reserves.
In total, 24 U.S. producers filed for bankruptcy in the second half of 2019, the most in any six-month period since 2016, according to law firm Haynes & Boone.
That could accelerate as banks further cut their assumptions for where oil prices will trade for the rest of this year, impacting how much they lend out.
At the start of March, before crude cratered, Citigroup was telling producers it planned to reduce the value it ascribed oil by about $2 below fall prices in the mid-$40s, according to a source briefed on the bank's plans.
Sentiment followed commodity prices lower. J.P. Morgan, one of the largest lenders to the U.S. energy industry, responded by cutting its value for oil in 2020 by a third to around $30 a barrel, according to two sources familiar with the bank's activities.
Tulsa, Oklahoma-based BOK Financial Corp., which has the highest percentage of energy loans of any American bank, revised its crude valuations twice in March due to the substantial change in prices, a spokesman for the lender said.
With oil prices volatile, it would be natural for banks to err toward conservative valuations for collateral. Yet, each lender price move shifts the chances of a producer retaining enough RBL cash to survive.
Citigroup and J.P. Morgan declined to comment.
Some U.S. energy companies, including Lilis Energy Inc. and Ultra Petroleum Corp., have already breached covenants or admitted they cannot repay their loans.
Others, such as Rosehill Resources Inc. and Whiting Petroleum Corp., have drawn down on their loans since the oil price slump, meaning any future reduction in RBL size could leave them overdrawn.
The wave of bankruptcies some expect might keep lenders from taking harsh actions to pull in credit lines. In the 2014-2016 oil price slump, banks granted customers some leniency through the formation of payment plans for deviant borrowers, giving them some time to regain compliance, bankers said.
Such moves would not be charity. Lenders are reluctant to seize properties, especially when the market for energy assets is so poor, and after being burned in recent oil bankruptcies.
Alta Mesa Resources Inc.'s restructuring plan, which collapsed earlier this month, had lenders getting back around half their money, an uncommon event as banks traditionally get all their cash returned as the highest-ranking creditors.
If banks took a hard line, there would be multiple sales from company liquidations, said one oil and gas lawyer.
"There aren't enough buyers for that. Banks would get pennies on the dollar," he said.
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