Since the third quarter of 2014, the appetite for lending to small and midsized exploration and production companies (E&P Companies) has decreased substantially for several reasons. The most significant reason is the drop in oil prices to the WTI Spot close at Cushing, Oklahoma in the $35 per barrel range at the end of 2015.
Exploration and production (E&P) loans in the United States are made available via a borrowing base, the value of which is driven by reserve reports prepared by reserve engineering companies. These reserve reports are generally only prepared semi-annually and incorporate the current prices for oil and gas as of the report date. Most reserve reports are prepared as of December 31 and June 30 of each year. However, the reports take several months to prepare and are not due to the lenders until early March and early September of each year respectively, although the value of the reserves is based on December 31 and June 30 numbers. Hence, E&P Companies with borrowing base credit facilities began feeling the effect of this price slide beginning in March 2015, based on the price of oil and gas as of the previous December 31.
E&P lenders have taken a similar approach to the decline in oil and gas (O&G) prices to that of the 2008-09 decline, which is to work with the E&P Companies as much as possible, tinker with the credit agreements around the edges, and only take action on those E&P Companies that are in critical condition. That said, prior to the price decline, the average E&P Company was only approximately 60 percent drawn on their credit facility. However, assuming O&G prices remain flat for the next six months, as currently projected by the futures market, this 40 percent cushion will continue to erode for leveraged companies with required active drilling programs between the April 2016 and the October 2016 borrowing base redeterminations.
With the continued decline of oil prices to below $30 per barrel since January 1, the downward pressure on prices from lifting the Iranian sanctions is now largely factored into the marketplace. Energy prices in 2016 are not expected to recover in any material way, and high value hedges will continue to roll-off each month. Consequently, borrowing base availability under credit facilities for E&P Companies is expected to decline in April and October of 2016, further reducing cash strapped operators’ ability to meet ongoing obligations. Further, financially sound E&P Companies have already announced significant decreases in capital expenditure budgets for 2016. As a result of all these pressures, we expect that E&P Company bankruptcies and restructurings will accelerate in 2016. Additionally, oil field service companies will continue to fight for the decreasing work volume (at already reduced rates) resulting from capital expenditure cuts at the operator level, which will drive more bankruptcies and restructurings in their market segment.
The price decline and related decrease in borrowing base availability has led to a number of high profile E&P Company Chapter 11 proceedings throughout the United States. Over three dozen E&P Company bankruptcies were filed in 2015 alone. Energy sector Chapter 11 filings represented more than 26% of all the Chapter 11 reorganizations filed in 2015, and 2016 does not promise to improve. As a result of these factors, as well as continued regulatory pressure on lenders to take action on troubled O&G portfolios, M&A activity in the E&P space is expected to increase in 2016. Buyer and seller price expectations are likely to converge in the wake of the April 2016 borrowing base redeterminations as E&P Companies recognize that they need to sell assets at realistic prices in order to meet ongoing cash demands. This forced realism will provide financially sound E&P Companies the opportunity to acquire future development properties, and investors their long awaited opportunity to acquire O&G assets at what they deem to be reasonable prices. E&P Company bankruptcies will also provide investors the chance to acquire O&G assets through the Section 363 bankruptcy sale process. All and all, O&G asset sales in 2016 should be very significant with some parties expressing concern that too much property for sale could drive assets prices below even market expectations. The O&G market was full of surprises in 2015, and 2016 is sure to bring twists and turns of its own