Investors hope to strike oil in budding oil and gas ABS market

Oil and gas securitizations may be a win-win solution for the difficulties faced both by energy producers in search of a diversified source of funds and by investors hungry for long term, attractive returns, said speakers at SFVegas on Sunday.

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The oil and gas securitization panel played to a packed house on the first day of SFVegas 2020, a telling sign of the growing curiosity around the nascent asset class. The panel featured a heavy Q&A session, with investors lobbing questions at panelists ranging from expected yields to potential risks of oil and gas ABS deals.

An oil and gas securitization is typically backed by proven developed producing (PDP) reserves, which represent the estimated remaining volume of resources expected to be extracted from an existing oil and gas well.

PDP reserves do not involve any drilling, a process that typically incurs high costs and depends heavily upon oil prices. Because PDP reserve securitizations deal with existing assets with just 1%-2% margin of error on calculating the resources underground, oil and gas PDP securitizations are less risky than investors may expect, panelists said. As a result, the actual operation of the reserves is quite simple and allows for a fairly stable cash flow, said Gregory Kabance, managing director at Fitch.

Oil and gas PDP securitizations that have come to the market so far have boasted attractive returns. Raisa Energy’s non-operating interest transaction and Diversified Gas’ operating interest deal saw its investment grade tranche reach yields of the high 4%-5% range, and the non-investment grade tranches touched high single digits, said John Siris of Guggenheim. Siris was the lead banker on the Raisa and Diversified oil transactions. 

Along with Guggenheim, Citi has been another early mover in the PDP securitization sector and is currently reviewing a number of opportunities, said Jazib Hasan, head of commodities structured finance and credit solutions for Citi.

“Citi has been a pioneer in the space, by bringing together its oil & gas, securitization and commodities expertise under a single umbrella,” Hasan told GlobalCapital ahead of the conference. “PDP Securitization is not a panacea for all E&P [exploration and production] companies, but has a place in the capital structure of most companies that have a good number of economical PDP wells.” Citi provides its own balance sheet as well as access to third party capital to oil and gas companies, he added.

Although there have only been two deals so far, the market can expect to see “a handful of names in the next few months,” an energy and infrastructure banker said. For example, Fitch Ratings alone is looking at rating six to seven deals in 2020, Kabance told GlobalCapital

Oil and gas securitizations have become a novel solution for E&P companies who are losing funding from the reserve based lending market.

“This is a good product which we’re able to achieve investment grade ratings from rating agencies like Fitch,” said Siris. “It provided a lot of appeal for asset managers like insurance companies and pension funds that we sell securitized bonds to and allow these [oil and gas] companies to diversify away from the bank markets.”

Furthermore, oil and gas ABS provides attractive returns as investors continue to scramble for yield. In the beginning, the typical investor base will likely be insurance companies and high net worth individuals who are already familiar with the energy industry, said an energy and project finance lawyer familiar with the first few oil and gas securitization deals. As the deal grows bigger, there may be seven to eight investors involved in a deal.

Despite the growing interest, the market may not see another oil and gas securitization until oil prices recover, said an executive at an E&P company currently looking to issue a securitization.

"I don't think you're going to see ton of activity until you see commodity prices recover a little bit because you're going to have to hedge 10 years for [a securitization] to make sense," the executive said. "Unless you're buying an asset tomorrow and securitizing it tomorrow, we're at 20 year lows in gas prices, so you need a price recovery for people to say 'now is the time to crystalize my cash flows at today's future curve’.”