Distressed lower 48 operators face a credit crisis
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The price of oil has dropped sharply, creating a dire situation for many US Lower 48 operators. For many, the fight is now on to cut costs and free up cash. Capex and dividends have been cut, buybacks curtailed, and, in some cases, hedges monetised. And with many operators hit with credit downgrades, the financial pressure is really rising.
I talked to Principal Analyst Robert Polk about the scale of the challenge, and the operators most at risk of a credit crunch.
The Lower 48 financial health gap has widened
The Wood Mackenzie Financial Health Index gives us a unique insight into company performance over time. It shows that the financial health of the Lower 48 has worsened significantly since the last downturn, leaving many operators more vulnerable to shocks.
There are varying degrees of financial distress. Well-hedged operators with flexible midstream commitments are better insulated from the low oil price. However, hedges across the sector are limited beyond 2020, with only a tiny share of production hedged in 2021 based on recent filings. If low prices persist, this will further cripple balance sheets.
Refinancing risk is growing for many upstream borrowers
According to our Lower 48 Corporate Debt Monitor, more than 50% of principal debt is due by 2025. Refinancing risk grows as nearer-term maturities loom and capital markets support erodes. This creates uncertainty for investors and amplifies the value of near-term cash flow.
What’s more, the oil price collapse came just ahead of borrowing base redetermination season. Upstream borrowers with secured reserve-based revolving credit facilities (RBLs) found themselves most exposed to the risk of having credit availability cut by commercial lenders.
Operators with strong 2020 hedge positions have some protection, but the overall impact of hedging will be limited.
Proved-developed-and-producing (PDP) reserves and hedge value are key factors in an RBL borrowing base valuation. We expect lenders to give very little credit to undeveloped reserves, as many future development options are simply not economic at current prices. Operators with strong 2020 hedge positions have some protection, but the overall impact of hedging will be limited.
Unsecured operators will typically have greater cash and credit facility availability. But depleting liquidity will still create additional stress.
The outlook is tougher for oil than for gas
Oil-focused operators could be hit harder than their gas-focused peers. The latter had already adjusted their businesses in response to persistently low prices. And the fall in gas prices hasn’t been as dramatic as the oil price.
What’s more, as lenders would already have used conservative gas prices the redeterminations may not be as severe. However, high debt loads still pose a threat as hedges begin to roll off in 2021.
Lender behaviour is a wildcard
During the last downturn in 2015/2016, banks generally offered both stable capital support and covenant concessions. But today’s environment is less favourable. Enhanced price uncertainty, regulatory guidelines on leveraged lending, and a lack of alternative funding sources all create headwinds.
We expect that banks will revise price decks down, reducing the available credit extended to borrowers. However, we also expect banks to try to manage their exposure without sending a large portion of the industry into default.
Of course, they will be very careful when selecting operators for leniency.
How will distressed operators respond?
We expect to see distressed operators draw down as much availability as possible in the upcoming months.
The most at-risk operators – those with high credit facility utilisation and stressed reserves – might now be on an accelerated path towards restructuring.
In the last downturn, many operators took proactive steps to boost their liquidity and financial flexibility by extending credit, accessing the capital markets and securing covenant relief. With many of these options not currently open to them, they now face the daunting challenge of preserving as much liquidity as possible. The most at-risk operators – those with high credit facility utilisation and stressed reserves – might now be on an accelerated path towards restructuring.
In this environment, sector consolidation becomes more likely and attractive M&A opportunities could emerge.
Find out more about the financial health of Lower 48 operators
Want to read our latest insight into the key trends emerging from the spring 2020 borrowing base redetermination season? Visit the store to read Borrowing base redeterminations: available credit deteriorating.
Interested in how well operators are positioned to survive the downturn? Our recent webinar, 'Energy credit markets – which companies are at risk?' explored this topic in detail. Fill in the form at the top of this page for a complimentary copy of the webinar slide pack.