Recovering prices stabilize oil and gas credits

Recovering oil prices brought much needed stability to the balance sheets of oil and gas borrowers that were on the brink of foreclosure through lockdowns, but the transition away from hydrocarbons poses an ongoing challenge for issuers

Rebounding oil prices and a resurgent energy demand supported a spike in high yield bond and leveraged loan issuance by energy companies through the course of 2021.

High yield bond and leveraged loan issuance by energy companies in the United States and Western and Southern Europe totaled US$108.8 billion in the first nine months of 2021, up more than 30% on the US$83.3 billion secured over the first nine months of 2020.

Activity was distributed fairly evenly across both bond and loan markets in both regions. In the US, for example, there was US$48.8 billion in leveraged loan issuance in the sector to the end of Q3 2021, versus US$43.6 billion in high yield bond issuance during the same period.

Energy sector issuance was particularly robust in Q2 2021 in the US, with US$41.1 billion in combined high yield bond and leveraged loan issuance—the highest quarterly total since Q2 2018 and the third highest quarterly total for issuance on Debtwire Par record.

Western and Southern Europe, meanwhile, saw US$7.6 billion in leveraged loans issued in the energy sector in the first nine months of the year versus US$8.9 billion in high yield bonds during that period—with Q1’s total of US$5.1 billion the highest quarter for high yield bond issuance in the energy sector in the region going back to 2015.

The value of existing oil and gas debt also improved significantly. In the spring of 2020, for example, oil and gas leveraged loans in the US were pricing at less than 55% of face value on average, according to Debtwire Par. By the end of September 2021, however, average loan prices in the secondary market had revived to more than 80% of face value.

Indeed, in September, oil and gas loans ranked among the biggest monthly advancers in US secondary loan markets with a term loan B (TLB) issued by refined petroleum wholesaler Gulf Finance appreciating by more than 14% in value on the previous month, while a pair of TLB facilities held by Panda Hummel, the gas-fired power station, recorded a 6.18% rise in month-on-month value, according to Debtwire Par.

A welcome price push

Improved access to loan and bond markets among energy issuers, coupled with the recovery in pricing for existing borrowings, correlated with rising oil prices. Pricing has made steady upward progress since April 2020—when the price per barrel for West Texas Intermediate (WTI) fell to below US$17 and left many oil fields uneconomic. WTI pricing broke through the US$80 per barrel level in October for the first time in five years and, as of November 24, 2021, has stayed within a narrow band at this level.

The improved pricing backdrop also provided much needed relief for oil and gas borrowers with reserve-based lending facilities (RBLs). RBLs provide financing linked to the value of the proved reserves of oil and gas companies, with borrowing bases typically valued twice each year, in the spring and fall.

Weak oil prices and limited production through lockdown periods saw the value of some RBL borrowing bases reduced by close to 50%, lowering the amount of liquidity available to RBL borrowers, eroding headroom and increasing risks for lenders.

The picture in 2021 has been much brighter. Ahead of the fall redeterminations, lenders and borrowers have anticipated either maintaining or growing the value of borrowing bases with the latter resulting in a corresponding increase in the availability of credit.

With lenders more comfortable, many oil and gas groups have had more flexibility to extend and pay down RBL facilities through the course of the year, and to tap other sources of funding.

After warning, in September 2020, that it may be unable to clear its redetermination assessment in January 2021, Africa-focused producer Tullow Oil was able to secure an extension of its redetermination test before securing a US$1.8 billion bond that it then used to repay its RBL and other debts. The producer now faces no material debt repayments before 2025.

US and Africa-focused deepwater producer Kosmos Energy, meanwhile, was able to raise financing of US$450 million in senior notes, priced at 7.5% and maturing in 2028, early in 2012. With this capital secured, Kosmos was able to amend and extend its RBL facility, pushing out the tenor of the loan by two years to 2027.

US-focused Talos Energy was also able to push out the maturity of its RBL, extending the tenor from May 2022 to November 2024. Stronger oil prices are expected to increase liquidity and reduce the amount of capital drawn from the RBL, strengthening Talos’s capital position. 

Energy transition challenge

Despite the recent improvement of available capital for oil and gas producers, energy transition initiatives will continue to pose a threat to the supply of finance for the sector as governments, businesses, banks and institutional investors maintain their collective focus on energy transition.

According to DivestInvest, a group campaigning for divestment from hydrocarbons, 1,485 institutions from 71 countries, representing assets worth US$39.2 billion, have committed to some form of fossil fuel divestment. According to the Banking on Climate Chaos 2021 report, 27 of the 60 largest banks in the world decreased lending to hydrocarbons businesses between 2016 and 2020.

As lenders continue to move away from traditional oil and gas financing, the supply of capital will gradually tighten over the long-term. As a result, restricted liquidity and higher cost of capital will remain themes that oil and gas producers will have to manage, including through liability management transactions and restructurings.

Capital supply for the oil and gas sector is tightening at the same time as businesses in the market undertake large investment projects to transition away from fossil fuels to renewables. They face the conundrum of keeping investors onside while paying for energy transition as they wind down the profitable hydrocarbon operations that generate the cash to fund the shift to net zero.

Preparing article for printing....
Receive Debt Explorer quarterly email updates when new data is available.