The oil and gas (O&G) upstream sector continues to face financing headwinds in the second half of 2020, with prolonged low oil prices and over-levered balance sheets pushing O&G producers into restructurings and bankruptcy.
High yield bond and leveraged loan values for the energy sector in North America and Western and Southern Europe as a whole fell from US$95.1 billion for the year to Q3 2019 to US$79 billion for the first nine months of 2020. The O&G sector has seen similar declines.
The price per barrel of West Texas Intermediate (WTI) crude, the American benchmark, has barely held at (or just below) the US$40 level. While this is an improvement on initial lockdown lows of less than US$20, it is still a third down on prices seen at the end of 2019.
Production costs for many operators are uneconomic at these levels and low prices have seen the S&P Oil & Gas Exploration & Production Select Industry Index shed 53% year-to-date (as of October 21, 2020).
Against this challenging trading backdrop, almost a third (31%) of US bankruptcy filings in September 2020 came from the O&G industry, according to Debtwire Par—more than any other sector by some margin. Oasis Petroleum and Lonestar Resources both filed for bankruptcy within one day of each other. Other energy companies to go into Chapter 11 include Chesapeake Energy, California Resources Corporation and Chaparral Energy.
In Europe, meanwhile, only the transport and automotive sectors suffered more ratings downgrades and negative outlook changes than the O&G industry did between March and October this year.
Limited scope for new borrowing
A select group of blue chip oil majors have been able to continue accessing capital markets to strengthen balance sheets and see out the current slump. BP, Shell, ExxonMobil, Chevron, Equinor, Total and Eni took on additional borrowings of US$60 billion between them in the second quarter of 2020 alone.
Big oil majors, meanwhile, with large balance sheets and upstream production designed to deliver profit with oil prices in the US$40 to $50 per barrel range, have been able to take on additional debt at low interest rates.
For O&G companies that do not qualify as investment grade and have higher production costs, however, bond and loan markets have offered little help.
Fall RBL redeterminations loom
The current round of reserve-based loan (RBL) redeterminations taking place from September through November 2020 pose further near-term financial risk for companies that have suffered since the initial lockdowns and are stretched financially.
RBL debt facilities provide capital to O&G companies based on their proved reserves and are reviewed twice a year, usually in spring and fall. Redeterminations of RBL borrowing bases are linked to oil prices and production forecasts, which have both faced downward pressure during the year.
A number of producers took double digit percentage cuts to the value of their borrowing bases in spring 2020, which has eroded the headroom that those producers have available on their facilities. The fall 2020 redeterminations could see similar double digit percentage cuts which could trigger defaults under the loan agreements or additional restructurings or workouts for those producers that survived the spring 2020 redeterminations.
Prior to the fall 2020 redeterminations, however, the pool of RBL borrowers had already started bifurcating. One group used spring 2020 reviews to renegotiate terms with lenders, and in some cases, bypass the fall 2020 redeterminations altogether to extend their capital runways until spring 2021. The second group, facing weaker financials, was unable to secure this runway and will face another cliff edge through the latest reviews.
For borrowers pushing up against the limits of their RBL facilities, options for other sources of liquidity are limited. Bond and loan markets have only accommodated blue chip producers and securing refinancing from other RBL lenders has been difficult, as most RBL lenders are focused on existing portfolios and reluctant to expand their books against the current backdrop. Aside from bankruptcy, borrowers could turn to non-bank lenders for RBL replacements and non-traditional financings such as payment production financing, where finance is provided against future production output. The drawbacks are that these facilities are expensive, of limited scale and the capital providers offering these products will most likely require a senior position in the capital structure, which is likely limited or prohibited by existing RBL facilities or other existing debt.
O&G producers that survived the initial disruption from COVID-19 have moved quickly to protect their balance sheets and lender relationships.
According to S&P, companies have focused on reducing debt, cutting costs, slowing drilling and cutting capital expenditures in order to improve their viability in the eyes of lenders, and the focus is now on operating within the limits of existing cashflows.
The priority placed on capital discipline and managing debt levels has helped some producers navigate the fall 2020 redeterminations and minimize haircuts to their RBLs. Centennial Resource Development, for example, saw its US$700 million borrowing base reaffirmed by its bank group in October 2020. Prior to the review of its borrowings, the business had paid down debt and improved its cash position.
Barring an unexpected increase in oil prices and consumer energy demand (with the latter unlikely in the near future given recent spikes in COVID-19 cases and a new wave or European lockdowns), oil companies across the board will have to get used to living within their means and keeping a tight rein on borrowing.