The reserve-based lending market has shrunk during the coronavirus pandemic, with both big banks and regional players who used to inject capital into the system pulling back.
The shale industry saw 46 exploration and production companies and 61 oil-field service companies file for bankruptcy in 2020, according to data from law firm Haynes and Boones. The only time the market has seen this many bankruptcies occur previously was in 2016, during the last oil crisis, when 142 companies went bankrupt.
Bankruptcy cases include big names such as Chesapeake and Ultra Petroleum, which has filed for insolvency once before, in 2016.
“The upstream oil and gas space continues to pay a heavy price for the previous 10 years of poor returns and negative investor sentiment,” said an ex-ABS investment banker who now works for an energy advisory company. “Despite the recovering commodities prices, we haven’t seen a return of capital from either legacy or new investors.”
Large banks, such as BMO, have exited the shale oil and gas investment banking business, leaving a sector that has failed to deliver profit for many years, even before the pandemic hit. The Canadian bank left in December. It used to hold about $5.5bn in oil and gas loans, according to a company investor presentation dated March 2020.
Other major institutions are highlighting ESG concerns as their reason for leaving the market, particularly European banks. Smaller regional banks are withdrawing after taking hits on their portfolios.
Public and private equity markets are also proving restrictive for smaller shale companies. Private equity funds that have traditionally invested in the sector are now focused on managing or cutting their exposures.
The funds are using what they are calling a “smash co” structure, combining two or more portfolio companies and selecting one management team to be the caretaker for the new, larger asset base, effectively reducing expenses. By sweeping all the resources together in one pool, PE funds hope to increase the chances for survival of the energy companies, sources said.
An opening for ABS
But the tougher funding conditions have provided an opportunity for securitization buyers, said a commodities investment banker. As shale companies grow desperate for cash, ABS is emerging as an attractive funding mechanism for those who can afford it.
Sources said bankers seemed “bullish” on the oil and gas ABS market, pointing to conversations they have had with contacts at Guggenheim and Citi, both leading players in the sector.
“They told me they had stuff working through the pipeline that they hope to announce this year,” one source told GlobalCapital.
Both Guggeinheim and Citi have been early movers in the energy ABS market, structuring deals for companies such as Diversified Gas & Oil and Raisa Energy.
There is demand among investors for these products, the commodities banker added. “People are looking for yield in well-structured deals,” he said. “I’m seeing a lot of large institutions saying that at the right price, [they] can deploy a lot of money.
“With senior investment grade notes in other sectors, investors are getting Libor plus 200bp, so if they can get a 5% or 6% coupon somewhere, it makes a world of a difference.”
In recent weeks, a company that connects investors to oil and gas assets said it was working on a pilot deal sized at $250m-$500m with an investor that has issued a securitization before, a person close to the matter told GlobalCapital.
“We are hoping to close everything in February or March,” the person said. “Now, we are trying to figure out which other ABS investors might be interested in oil and gas assets.”
Another source at a rating agency was able to confirm that this deal was in the pipeline and near completion.
Recovering, but not fast enough
Oil prices have risen to about $56 for a barrel of Brent Crude from last year’s low of about $20, thanks in part to the promise of a $1.9tr stimulus package from US president Joe Biden.
Biden, far more eager to deploy policy to combat climate change than his predecessor, Donald Trump, is not seen as friendly to the shale industry. Nonetheless, companies have been encouraged by the invigorating effect a big spending bill will have on the economy.
In years past, increasing oil prices have caused capital to gradually flow back into the energy sector. That has not happened yet, nor will it happen any time soon, said an executive at an energy advisory firm.
The first problem has to do with the time it takes for the thousands of oil rigs to be “turned back on” after being left idle for a long time. There may also be staffing problems with industry professionals who used to run the rigs having left the industry during the pandemic.
“We have a lot of investors trying to prepare for demand to swing back, but we just don’t know when that will happen, and at what price point demand will come back into the space,” he said.