The majority of speculative-grade exploration and production (E&P) companies rated by S&P Global Ratings reported material cuts to their reserve-based loan (RBL) credit facilities after completing the semiannual redetermination process with their banks. The cuts come after banks slashed their price assumptions and looked to pull back exposure to the sector, following the collapse in crude oil prices that began in early March. This redetermination cycle has been more prolonged and less forgiving than previous cycles, with a number of the most distressed E&Ps still working through the process.

RBLs have a borrowing base amount determined by the value of the collateral, and an elected commitment amount, which is the amount of credit the companies and their bank groups have agreed to make available. The elected commitment is often kept at less than the borrowing base amount because of a number of factors, including keeping fees lower on unused commitment amounts. This usually provides a cushion to companies: if borrowing bases are cut, their elected commitments--the credit actually available to the company--would often not be as materially impacted. For the 34 rated companies that have announced the outcome of the redetermination process so far, the average borrowing base was cut by 23% and the average elected commitment amount was cut by 15%. For 80% of these companies, the elected commitments now match the borrowing base amounts (up from 40% pre-redetermination), which could be troublesome in the fall redetermination cycle as any reduction in borrowing base would directly impact the available liquidity.

The sharpest reductions resulted in deficiencies for borrowers

Chaparral Energy Inc. (CCC-/Negative/--) and Oasis Petroleum Inc. (CCC+/Negative/--) suffered the most severe cuts in percentage terms, having had their elected commitments cut by 46% and 44%, respectively. For a few companies, the reductions resulted in deficiency situations, whereby the elected commitments were cut to a level below the amount already drawn, requiring them to repay the excess balance in installments over the subsequent six months. This was the case for Chaparral Energy, Bruin E&P Partners LLC (CC/Negative/--), and Jonah Energy LLC (CCC-/Negative/--), and all three instances contributed to negative rating actions. Bruin recently disclosed that it had failed to make its initial deficiency payment for May and is evaluating strategic alternatives.

Table 1

Only a handful of companies were able to maintain or increase their borrowing base and elected commitment amounts, including Parsley Energy LLC. (BB/Stable/--) and WPX Energy (BB-/Stable/--), who both benefited from recently closed acquisitions that bolstered the collateral value backing their credit facilities. Although Matador Resources Co. (B-/Negative/--) maintained its borrowing base and increased its elected commitment by 40%, this was primarily due to the company completing the process early in February, prior to the oil price collapse.

Chart 1

Banks' lower price decks led to lower collateral values

The credit facilities of most speculative-grade E&P companies are collateralized by their crude oil and natural gas proved reserves. The banks reassess the collateral values on a semiannual basis using their internal price assumptions. The banks ascribe greater value to reserves that are developed and producing, compared with undeveloped reserves that carry additional risk and cost to develop, and exclude value for the reserves that will be produced over the immediate six month period. Although the banks generally do not disclose their price assumptions, our understanding is that in this most recent cycle oil prices were cut to about $30 per barrel (/bbl) for the remainder of 2020, stepping up to about $35/bbl in 2021, and $40/bbl in 2022 and thereafter. Gas prices remained relatively stable from the previous redetermination cycle, starting at about $1.90 per thousand cubic feet (/Mcf) for the remainder of 2020 and increasing to about $2.25/Mcf by 2022. The banks give credit for commodity price hedging, which they assess on a six-month roll-forward basis, and we believe this shielded a number of well-hedged E&Ps from more punitive RBL reductions this time around.

Restrictive amendments put a tighter leash on borrowers

In addition to the reductions in facility size, many companies disclosed amendments to their credit agreements that introduced more restrictive lending conditions. These included lower leverage thresholds for financial covenants, anti-cash hoarding restrictions, reduced dividend caps, higher interest rates, and limits on the amount of unsecured debt that can be repurchased. These amendments point to the waning confidence and risk tolerance that the banks have for the sector.

Cuts in elected commitments leave companies with highly drawn balances and limited liquidity

The average RBL balance drawn post-redetermination jumped to 53%, from 36% at Dec. 31, 2019. In addition, roughly one third of companies had drawn more than 70% of their available elected commitments, which illustrates the liquidity crunch the group is now facing, particularly given the current lack of access to capital markets and limited ability of companies to generate positive free cash flow at current prices. Companies like Oasis Petroleum and Callon Petroleum Co. (CCC+/Negative/--), who had each drawn more than 80% of their available credit, are now under pressure to reduce their borrowings and could easily find themselves in deficiency situations if their facilities are cut further in the fall redetermination cycle. Chesapeake Energy Corp. (D/--/--) on June 17 announced the bank had cut its borrowing base by 23%, which pushed its last disclosed amount drawn to 86% of its commitments. Chesapeake, which has been struggling with its debt load, also disclosed it had missed interest payments that were due on June 15.

Chart 2

Fall redeterminations could be a repeat of the spring

Although oil prices have improved from the lows seen in March and April, they have remained volatile and the uncertain demand outlook continues to hang over the sector. If the oil markets don't improve or stabilize by the fall, there is a high likelihood that banks could make another round of sharp cuts to credit facilities. The companies most at risk will be those with limited hedging, near-term debt maturities, tight liquidity, and highly drawn credit facilities. And ultimately, even the stronger companies and those that were spared in the most recent redeterminations could be at risk. Lastly, the significant decline in drilling activity in 2020 will result in fewer reserves being converted from the lower-value proved undeveloped to higher-value proved developed category, which will have an impact on borrowing bases too. Additional cuts would place further strain on liquidity and heighten the risk of additional debt exchanges or restructurings, potentially driving a new wave of negative ratings actions.

Note:

Our analysis excludes several recent "fallen angels" (companies that we downgraded from investment- to speculative-grade) that have maintained unsecured credit facilities that they entered into when they held investment-grade ratings, as these facilities are not subject to the semiannual bank redetermination process. This includes Occidental Petroleum Corp. (BB+/CW Neg/--), Continental Resources Inc. (BB+/Negative/--), Apache Corp. (BB+/Negative/--), EQT Corp. (BB-/Neg), and Murphy Oil Corp. (BB/Negative/--). We also exclude rated companies that have yet to complete and report the outcome of the redetermination process. These are primarily lower-rated companies ('CCC+' or below) already in distressed situations, including Denbury Resources Inc. (CCC+/Negative/--) and California Resources Corp. (CC/Negative/--).

The ratings in this document are as of June 18, 2020.

(Griffin Marsh contributed to this article.)