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Cutbacks, buyouts and burnouts as E&P markets reshape


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Cutbacks, buyouts and burnouts as E&P markets reshape

A weekly recap of SNL Energy'scoverage of major themes in the natural gas industry.

Witha full commodity price recovery not anticipated soon, oil and gas companies — andthe analysts who cover them — are bracing for a turbulent year.

The comingspring round of bank redeterminationscould be particularly bloody, according to analysts, and a number of producers withheavy debt loads know they have a lot riding on the next round. If a lender decidesto cut a company's borrowing base below what it already owes, the debt could beaccelerated and come due immediately, causing the producer's balance sheet to collapse.

"Thereare more than 50 companies that have already entered Chapter 11 proceedings andmost are not coming back, unless oil prices rebound above $60 per barrel,"Oppenheimer & Co. Inc. analyst Fadel Gheit said.

"Theprocess will likely be a hard look at the recoverable assets in the current marketand the borrowing bases likely are cut to that level or below, so the banks at leasthave asset coverage," Jason Wangler, an analyst at Wunderlich Securities Inc.,explained in an interview.

The cutsare expected to be widespread and potentially substantial.

"Mostall should see some reduction, and most are estimating around 30% reductions … butthere will be a wide range of cuts," Wangler said.

Pricesof West Texas Intermediate crude oil reboundedoff their Feb. 11 low around $26 per barrel to reach about $42 in March, a rallysparked when news broke that OPEC was readyto cooperate on freezing production levels. But there is not widespreadsentiment that the rally can sustain itself.

The likelihoodof significant M&A activityin the sector has increased as hope of higher oil and gas prices fades, said SidleyAustin LLP's Irving Rotter, a partner and co-leader of the firm's project financeand infrastructure practice.

Privateequity firms are preparing to pounce on appealing targets as the spread betweenwhat buyers are willing to offer and what sellers are expecting starts to narrow,Rotter said. The spread has narrowed as more potential deal participants lower theirexpectations for oil and gas prices in 2016 and 2017.

"You'retrying to get to a meeting place with buyers and sellers," Rotter explained."Finding that point where buyers and sellers are willing to trade, at thispoint, is recognition by sellers that the market isn't coming back as quickly asthey hoped. The stresses are taking their toll. Buyers, on the other hand, are becomingmore comfortable with where the bottom point is."

The absenceof price spikes or declines over the past several months, Rotter said, has helpedbuyers become comfortable. Many are starting to think they will not get a betterdeal by staying on the sidelines.

"Nowyou're starting to see an uptick in activity. They're making trades with privateclients or deals with public companies that have assets that are no longer core,"Rotter said.

Privateequity firms that have been circling may be more likely to strike given the expectedcuts in borrowing bases of both upstream and midstream companies. "The questionis going to be how the sellers react [after redeterminations]," Rotter said."If they have gotten to the point where they have to transact, where they haveto get additional sources of liquidity, [private equity] will be ready."

The industryis awaiting higher prices to help the balance sheets of most oil and gas producersand for some drilling rigs to be put back to work, said Rusty Braziel, presidentof RBN Energy. But he said the market is only slowly correcting itself.

"Thefact that $40 a barrel should be considered 'good news' is sobering: Eighteen monthsago, that price level would have been seen as a catastrophe for the producing community,"Braziel said. "At $40 a barrel, producer returns for drilling most shale wellsare underwater."

Analystsat Jefferies agreed, saying $40 will not support any significant increases in capitalspending within the industry.

On theother hand, cutbacks incapital expenditures and drilling by U.S. oil and gas producers are helping balancethe market, Morningstar analyst David Meats said.

"Productionin the U.S. is certainly rolling over and that's a good thing, and at least youhave the first signs of discontent in the Middle East," Meats said in an interviewMarch 30 after issuing an investor note on the topic. "I'm fairly skepticalon real cuts coming in the Middle East, except that you have countries like SaudiArabia and Russia that are actually talking about this stuff. But a second yearof substantial CapEx cuts and the collapse in rig counts [in the U.S.] is startingto have an effect."

Gettingto the point where supply and demand for oil is equal again, however, depends onmany more factors than just producers cutting back.

Any changeto the supply/demand equation would appear to be at least a number of months awayfrom taking hold due to tepid demand growth and a large amount of existing reserves,Meats said.

"There'snot going to be much of a change in the near term," he said. "U.S. outputis slowing, and OPEC output is at least growing less quickly, but demand is growingslowly, as well. Markets won't come back into balance until late 2016 or early 2017at the earliest."