Analyst predictions for cuts to fall base borrowing deepen for small and mid-cap exploration and production companies that depend on banker credit and support.
Small and mid-cap exploration and production (E&P) companies have been bracing for the fall recalculation of their bank lines of credit since the post-spring markets continued to leave oil in the ground and commodity prices on the floor.
And an industry brief from Raymond James and Associates suggests the cuts could be much deeper than those earlier this year.
“We think fall borrowing base redeterminations will likely be more punitive this fall, leading to a 15 to 20 percent reduction in overall U.S. E&P bank credit facilities,” the analysts said in an Oct. 12 brief.
Taking into account that company hedge books continue to fall off; proved undeveloped (PUD) reserves are likely to drop with the slowdown in drilling; the government is getting involved; and a general lower price deck, RayJa said borrowing bases could drop an average of up to a quarter.
“Depending on the outcome of this process, we could see the fall redetermination potentially kick off a wave of mergers, property deals and even some corporate restructuring,” they said.
Generally, companies haven’t been keen on selling assets at bargain basement prices, but if the RayJa theory holds up, their choices are diminishing. Insiders have said that expected mergers and acquisitions activity has been on a slow roll, but third and fourth quarter activity may change that.
Back in the spring, bankers cut many companies some slack, likely anticipating a rebound in oil prices. The average borrowing base valuations dropped a typical 12 percent in the spring. Some bankers, lawyers and analysts have predicted a similar decline in credit this fall. But others have taken a more somber view, suggesting declines of more than 30 percent. And oil prices, if consistent, are in an opt-repeated “lower for longer” mode.
This biannual credit check is rarely on the energy finance community’s radar. As RayJa explained, it’s a regular process in which banks revise their price and volume assumptions to decide how much debt they’re willing to give an E&P company.
“Usually it is not a big deal because it would take a significant move in either price or volume to change the debt limit. Given the large decline in oil prices, combined with the slowdown in drilling activity over the past year, it is a big deal now because reserve values are falling sharply,” RayJa said.
What’s more, even if oil prices steady or bounce back, RayJa said these companies are set up for more borrowing base cuts.
“While this fall’s borrowing base determination season will be uncomfortable for some, we likely have not reached the bottom of borrowing base reductions,” they said.
Problems this year become real trouble when you throw in declines in domestic oil production based on dramatic cuts in capital expenditures; six moth hedge values fall off the books; and banks becoming more conservative.
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