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Feature: Oil and gas E&P credit lines could rise nominally

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Feature: Oil and gas E&P credit lines could rise nominally

Highlights

Higher stable oil price inspires confidence

Banks cautious, but willing to open pockets

Sector adjusting to short-term price fluctuations

Stable oil prices at higher levels than a year ago, as well as expanded upstream capital budgets and more drilling, are likely to boost bank credit lines by nominal amounts for oil and gas producers and allow them to continue robust production growth, analysts say.

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Crude prices that pushed through the psychological $50/b barrier late last year and largely remained there have revved up drilling engines in the oil patch and pushed up production in key US basins, notably the Permian in West Texas/New Mexico, and to a lesser extent the Eagle Ford Shale of South Texas.

That will add to oil and gas reserves, a key metric used to gauge operators' creditworthiness. And this, along with extra cash from more output, means producers may qualify for higher funding levels during lenders' first of two yearly re-evaluation rounds for the sector this month.



"You'd think more production would mean banks wouldn't be bullish on increasing borrowing bases," Kraig Grahmann, a partner at law firm Haynes and Boone's energy practice group, said. "But we've identified a bit of a floor in oil prices and so banks are seeing more of a comfort level."

Last week, Haynes and Boone released results from a survey of 163 energy and financial executives on upstream credit redeterminations. The poll found respondents expect to see the borrowing bases of 76% of producers increase slightly (on average 10%) during the current round or remain unchanged, compared with 59% last October.


UNRUFFLED BY PRICE PULLBACK


Moreover, executives appeared relatively unruffled by a slight pullback in oil prices below what is popularly called the "magic" $50/b mark last month, when Haynes and Boone took the poll.

One-third of those who took the survey did so after the week of March 6-10, Grahmann said, during which the price of oil fell about 9%.

Those executives were "slightly more pessimistic" than those surveyed before the price drop, he said. But "the conclusion we drew was that while bankers and producers are cautious ... they've gotten used to the idea that short-term, we could see these fluctuations that work themselves out into long-term price stability."

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Higher oil and gas prices also point to banks' willingness to lend, Brian Kessens, managing director for Tortoise Capital Advisors, said.

"If you look where oil and gas strip prices are now versus a year ago, oil is about $10 higher, and gas is about 50 cents higher," Kessens said. "You have better commodity price decks that banks are using to value reserves."

Moreover, the fact that lenders have backed a slew of acquisitions for E&P companies over the past nine to 12 months also shows confidence in the current market, Ray Ballotta, partner of M&A transaction services for Deloitte LLP, said.

"They are back in the space and expanding credit lines," Ballotta said.

While few oil companies have released news of their new borrowing bases -- a second round of redeterminations occurs in October -- an announcement from one small East Texas operator could serve as a proxy for what is widely expected this time around.

WildHorse Resource Development Corporation said last week its credit facility had increased to $450 million -- up 24% from its prior borrowing base of $363 million. The company had its initial public offering in December.

Many E&P companies have asset-based credit lines tied to the value of their proved oil and gas reserves, a process known as reserve-based lending. According to Debra Gatison Hatter, a partner at Dallas-based law firm Strasburger, about a third of Lower 48 US oil production comes from companies with reserve-based loans.


BORROWING TERMS STILL CONSERVATIVE


But borrowing terms still remain conservative, a cautious holdover due to the recent two-year industry downturn that saw oil prices drop from $100/b in mid-2014 to around $26/b briefly in early 2016.

Compared with a year ago, lenders have added cash anti-hoarding provisions, meaning they cannot draw down their full revolvers and sit on war chests, Ballotta said. And the overall leverage banks require is lower: 3.5 times debt-to-EBITDAX (earnings before interest, taxes, depreciation, amortization and exploration), compared with five times a year or two ago.

Also, regulators have formulated guidelines making it harder for lenders to keep extending credit to distressed operators that do not maintain a sufficient level of oil and gas reserves, Grahmann said.

In effect, "it's more difficult [for lenders] to kick the can down the road," he said.

The October 2016 round of bank redeterminations occurred at a time when producers, enthusiastic over oil at or near $50/b, started to add rigs in preparation for what they believed would be higher spending this year. That also was before OPEC agreed to production cuts the following month of around 1.2 million b/d, while non-OPEC nations agreed to cut more than 500,000 b/d.

OPEC will meet in May to determine whether to extend those cuts. Also, by August or September, more data on levels of global oil inventories should be available, which could signal whether oil prices are likely to remain around existing levels or notch up.

"That should affect what happens with fall" bank redeterminations, Grahmann said.

--Starr Spencer, starr.spencer@spglobal.com

--Edited by Annie Siebert, ann.siebert@spglobal.com