Oil and gas companies have April circled on their calendars.
That’s when their lenders will recalculate the value of properties that energy companies staked as loan collateral. With those assets in decline along with oil prices, banks are preparing to cut the amount they’re willing to lend, crimping the ability of U.S. drillers to keep production growing, Bloomberg said Jan. 20.
“This could start a downward spiral for some of these companies because liquidity will dry up,” said Thomas Watters, managing director of oil and gas research for Standard & Poor’s (S&P) in New York. “I call it a liquidity spiral. They’ll start burning right through cash.”
More than 20 U.S. exploration and production companies have used at least 60% of their credit lines, according to Bloomberg Intelligence analyst Spencer Cutter. The energy industry is facing a cash squeeze after U.S. oil prices fell 60 % since June. Drillers have already cut spending to conserve cash. If credit lines are cut, the most indebted producers will be left scrambling to raise money elsewhere. New loans will be expensive -- if they’re available at all.
The credit lines, which typically are reset each spring and fall based on the value of borrowers’ petroleum reserves, operate like credit cards. To pay them off, companies have in the past sold off assets or issued bonds. The value of oil properties has declined at the same time that the borrowing environment for energy companies has gotten worse.
At least one junk-rated company, Breitburn Energy Partners LP (NYSE: BBEP), has gotten an early jump on discussions with its lender. Breitburn’s credit limit was raised to $2.5 billion from $1.6 billion on Nov. 19 as a result of the acquisition of another energy company.
About three months ago, Los Angeles-based Breitburn attempted to sell $400 million of bonds to pay down its $2.5 billion credit line, but canceled the offering as oil falling below $90 a barrel (bbl) roiled credit markets. The credit line is 88% drawn, according to regulatory filings.
With the high-yield energy market still “challenged,” Breitburn is considering tapping the loan market, Jim Jackson, the oil producers’ CFO, said in a phone interview.
If its credit line is reduced to below what’s already been borrowed, “we would have six months to close that gap,” he said. “We’re being very proactive.”
Last week, S&P said it might downgrade Breitburn’s credit rating over concerns the company would face cash shortfalls if it couldn’t replace money from a reduced credit line.
Energy companies with low speculative credit ratings are “largely shut out” from the high-yield bond market, according to Brian Gibbons, a senior analyst for oil and gas at CreditSights Inc. in New York.
Borrowing costs have skyrocketed as crude prices have fallen. Yields on junk-rated energy bonds climbed to a more than-five-year high of 10.4% in December, from 5.7% in June, when oil was at more than $100/bbl, according to Bank of America Merrill Lynch index data. That means a borrower would pay almost $25 million more in interest a year on a $500 million bond. The yield averaged 9.7% on Jan. 16.
Defaults will probably be “limited” in 2015, but could top 20% next year if oil stays below $60, Barclays Plc (NYSE: BCS) analysts said this month in a research note.
U.S. oil output rose to the highest in more than three decades, according to the U.S. Energy Information Administration. To maintain the pace, shale companies need to keep drilling new wells, which many of them fund with borrowed money.
Companies pinched by reduced credit lines might find financing in the loan market. The experience of Resolute Energy Corp. (NYSE: REN) shows that won’t come cheap.
The Denver-based driller said Dec. 31 it obtained a second-lien loan from Highbridge Capital Management LLC and will pay interest at 10 percentage points more than Libor, with a 1% minimum on the lending benchmark.
Second-lien loans are generally more expensive for borrowers because they provide investors less protection against default.
Apart from evaluating ways to raise money in the capital markets, companies are also cutting spending and looking to sell assets or merge, according to Stephen Trauber, global head of energy investment banking at Citigroup Inc. (NYSE: C) in Houston.
“You’ll see consolidation in the next 12 to 24 months,” he said.
Like Breitburn, other companies are probably “trying to get an early read on the tea leaves from their lenders,” said Gibbons of CreditSights.
Midstates Petroleum Co. (NYSE: MPO), a Houston-based oil and gas producer, used up about 70% of its $525 million borrowing base as of the end of September, according to data compiled by Bloomberg. The company’s $700 million of 9.25% bonds due in 2021 have tumbled to 44.75 cents on the dollar from above par in early October, according to Trace. They yield 28.5%.
Chris Delange, a spokesman for Midstates, declined to comment on the company’s finances.
S&P downgraded Midstates on Jan. 16 on concerns that lenders will slash its credit line.
“Energy companies will be in cash conservation mode this year,” said George Bory, the New York-based head of credit strategy at Wells Fargo Securities LLC. “It starts with capital budgets being cut and many have already started down that path.”
Swift Energy Co. (NYSE: SFY), a 35-year-old Houston-based driller that expanded into shale in recent years, has spent more money than it made for three consecutive years, pushing its total debt to more than $1 billion, Bloomberg data show. The company has drawn almost half its $417.6 million credit line, according to the data.
The cash shortfall has forced Swift to put assets on the auction block and cut spending. On Jan. 13, the company reduced its 2015 drilling budget to between $100 million and $125 million. That was after announcing in November that it would spend between $240 million and $260 million, a level that would keep its production flat.
Representatives for Swift didn’t return calls and emails seeking comment.
S&P downgraded Swift on Jan. 16, citing lower production in 2015 and 2016.
Denver-based Venoco Inc., Calgary, Alberta-based Lightstream Resources Ltd. (TO: LTS) and Magnum Hunter Resources Corp. (NYSE: MHR) and Goodrich Petroleum Corp. (NYSE: GDP), both based in Houston, also have the “greatest exposure” to reductions in their borrowing bases, according to a Jan. 19 CreditSights report.
Lightstream said Jan. 19 it’ll be “proactive” in managing its debt and expects to renegotiate terms of its credit agreement with lenders to avoid covenant issues as oil prices remain below $50/bbl.
“Everyone has been spending more than they got,” Gibbons said. “They’re trying to cut their cash flow shortfalls to as close to zero as possible.”