Until recently, there was little call for restructuring and turnaround specialists in the UK to focus on the oil and gas industry. That has now undoubtedly changed. In the second half of 2014, Brent crude prices fell from over US$100 a barrel to around US$50, and although prices have since stabilised (currently near the US$60 mark), a low price environment in the medium term seems likely. That is not bad news for all in the oil and gas industry. But for upstream operators focusing on exploration and production in the North Sea, it presents undoubted challenges, despite the tax concessions George Osborne announced in the March 2015 Budget. Byron Nurse and Humphrey Douglas consider some of the key questions those financing them are likely to be asking.
How sensitive is the company's business to a low oil price?
While a low oil price is a global phenomenon, the risk of distress in the North Sea industry is compounded by at least two other factors:
- The North Sea is a mature production area in which costs of extraction are high and getting higher, compounded by stringent decommissioning security requirements.
- Upstream activity in the North Sea is no longer dominated by the largest international players. A raft of M&A activity has seen many fields owned by relatively small, independent operators. They may be more sensitive than larger companies to adverse market conditions.
A creditor needs to consider not only its customer's own operations and cashflows, but the extent to which it relies on other companies that may be facing distress. The second half of 2014 saw a marked rise in insolvencies of UK-based oil and gas servicing companies.
How tight are the company's financing terms?
Even a business adversely affected by the current market conditions may have a low risk of imminent default if it has agreed favourable financing terms. This is likely to benefit larger companies, particularly those that have had access to the debt capital markets. Bond covenants are often "incurrence" rather than "maintenance" in nature. This means they are not tested periodically, but only when the borrower takes a voluntary action, such as incurring new debt or selling an asset.
By contrast, many oil and gas companies operating in the North Sea obtain their debt primarily from reserve based lending (RBL) facilities. Under RBL facilities, the amount of debt available at any time is based on the net present value of proven (and sometime also probable) undeveloped reserves in the relevant field(s), up to a maximum facility amount. The value of this "borrowing base" is recalculated periodically, typically twice a year. For a fully drawn borrower, a significant oil price drop is therefore likely to trigger a significant loan repayment obligation once that price change flows through into the borrowing base.
What are the company's key assets and are they effectively secured?
All oil in UK territorial waters and the UK continental shelf belongs to the Crown until it reaches the well head. (In contrast, US oil companies own, and their lenders can therefore take security over, hydrocarbons before extraction.) So, the majority of the company's value is likely to be split between:
- its licence to continue to extract hydrocarbons in the future. This will have been issued to it by the Department of Energy and Climate Change (DECC) under the Petroleum Act 1998; and
- (in some cases) hydrocarbons it has extracted but not yet sold.
Neither is an ideal security asset. Any security over extracted hydrocarbons is likely to be floating rather than fixed in nature: the company will be free to sell them in the ordinary course of business. It is possible to take security over a licence interest: the Secretary of State has issued an "Open Permission" for licensing rights to be "charged by way of security". However, the Secretary of State also has power to revoke the licence itself on any insolvency, security enforcement or other balance sheet restructuring affecting the licence holder. So, however extensive a lender's security package may be, it is likely to need Government approval before exercising any of its enforcement rights.
What difficulties might arise on a sale of the business?
Both formal and informal restructurings often involve the sale of the distressed business. Are there likely to be any particular difficulties selling an oil and gas business?
- Licence transfer. Any transfer of a licence interest requires the Secretary of State's consent. A share sale does not entirely avoid this complication. Any change in control of a licensee is likely to be a ground for revocation of the licence, although it may be possible to obtain comfort from DECC that it will not exercise that right.
- Decommissioning. Any purchaser taking on a licence will need to take on the decommissioning obligations that go with it. However, the original licence holder will remain liable for decommissioning obligations unless and until the Secretary of State releases it from them. It is only likely to do so once it is satisfied of the security arrangements offered by the new licence holder. Indeed, DECC's recent practice is not to issue releases, leaving previous licensees with residual liability.
What restructuring and insolvency mechanisms would be available to the company?
There is no specialist UK insolvency regime for oil and gas companies, but there are a range of formal restructuring mechanisms under English law that may help in a restructuring. It is not uncommon for an English law RBL facility to be pooled across UK and non-UK fields and for different locally incorporated companies to hold those fields. The following may be particularly relevant in that context:
- An English scheme of arrangement can potentially be used to restructure the English law debt of both English companies and other group companies with limited (other) connection to England.
- English administration (which provides a general moratorium) may be available to both English and other group companies by migrating, to the extent necessary, each company's centre of main interests (or COMI) to England beforehand.
However, neither these nor any other restructuring steps are likely to be possible without a close dialogue with the UK Government.