April 15, 2015
In 2014, twenty-two exploration and production companies successfully sold equity share offerings, but as access to capital tightens, greater vulnerabilities are beginning to emerge. Conversely, Shell’s announcement of their acquisition of BG Group has brought a fresh wave of speculation regarding consolidation in the sector. As the sustained low-oil-price environment drags on and access to capital is impacted, the picture is becoming increasingly clear as to who will be the likely winners and losers in this game of thrones.
As they assess their capital situation, companies in the oil and gas industry are not only experiencing a shift in capital access, but also in the identities of those providing the capital as well. It would seem as if we are witnessing an evolving lending landscape which is moving away from traditional banking sources towards deal-driven private equity firms. Most companies have traditional bank loans with the underlying borrowing capacity tied to the value of their reserves. This borrowing capacity is “redetermined” several times per year, and April is the next inflection point for this analysis. It is expected that the more cash poor borrowers will face reductions in available credit that they can ill afford. The supply chain of companies providing goods and services to these oil and gas providers will be affected as well.
Granted, many banks will not force companies to act immediately, and breaches of credit agreement covenants at or below the ten percent range are likely to be “worked out” with the lenders. However, more serious breaches will require a new funding source, and this is where private equity funds come on the scene. Private equity investors, always looking for high-return investment opportunities, are increasingly seeing an imbalance between short-term credit supply and availability of distressed assets. As they acquire both debt and traditional equity positions, the private equity funds will demand enhanced returns and the funding landscape will look markedly different.
Companies with the best chance of negotiating more reasonable terms with private equity funds (or issue debt that will be acquired by such firms) are those with proven assets, low development costs and low capital expenditure requirements. As such, the oil-services companies that cater to ongoing operations such as helicopters and maintenance for offshore rigs, which have been hurt as much as the rest of the industry are of interest to these investors. US shale operators, though in a bind, are also of great interest. They need cash to stay afloat until prices rebound, but many have made significant strides in lowering their cost structure and only a partial price recovery could see them operating at breakeven. Offshore drilling rigs and construction vessels on the other hand are likely to have the toughest terms put on them given the broader retrenchment from expensive exploration plays and the divestment of non-core assets from the majors — the demand outlook for these companies looks weak.
For the weakest of these companies, restructuring of credit terms and operations will occur, and these will be expensive. M&A is likely a route for the more liquid companies as numerous private equity firms are looking to pick up distressed oil services providers and their assets at bargain prices. However, the real winners (on both sides) will be buyers and sellers who explore creative non-cash structures, such as mezzanine financing, project-equity arrangements and farm-ins (a contractual agreement with an owner who holds a working interest in an oil and gas lease to assign all or part of it to the private equity investor effectively trading a working interest in return for some or all of the drilling costs to help a cash strapped company get about its business.) Private equity investors like this strategy because it allows them to invest in high quality assets. Companies like it because they can get cash to execute on their plans and only give up a portion of the upside.
At Ankura Consulting Group, we will help our clients better assess their optimal roadmap to take advantage of the new form of credit financing and their new private equity partners. Our objective is to provide a broad range of restructuring, bankruptcy and insolvency expert services that allow for the successful completion of an investment decision or debt restructuring. Our combined experience in many multi-faceted situations enable us to bring perspective, offer objective counsel and undertake the necessary analysis to assist our clients in achieving their objectives.