Banks may cut oil reserve values by up to 30pc

OREANDA-NEWS. September 01, 2015. Banks may cut oil producers' reserve values by up to 30pc in the coming months, potentially pushing companies with high levels of debt closer to bankruptcy.

Lenders typically assess the value of the oil and gas reserves twice a year in part based on average market prices, in an exercise known as asset redetermination. For producers big and small reserves are their key asset against which they take out loans or lines of credit. With oil having fallen to six-and-half-a-year lows, those assets are now worth a lot less than they were a year ago.

In the spring many banks opted to waive the redetermination for oil and gas producers amid expectations that the drop in prices was temporary. But with low prices proving to be persistent, and bank regulators less willing to let banks disregard the risks, this fall's redeterminations could be tough. In some cases producers with high levels of debt may find their assets are worth less than their loans outstanding.

"I do expect to see more bankruptcies," said John Bitter, energy partner at accounting firm PwC. "It is certainly possible that smaller companies could be impacted more so, generally speaking than larger companies."

A number of smaller producers have already declared bankruptcy. Samson Resources, which was acquired by private equity giant KKR for \\$7.2bn in 2011, filed for bankruptcy this month, citing the steep crude prices. Other recent Chapter 11 filers include Saratoga Resouces, Quicksilver Resources, Dune Energy and American Eagle Energy.

Some companies are taking proactive measures to prepare for the fall. Goodrich Petroleum has halted its dividend payment, for example, while producers under pressure, such as SandRidge Energy and Halcon Resources, have said they are renegotiating their debt terms, including converting a part of it into equity to improve their balance sheets.

Pearce Hammond, Managing director of institutional research at Simmons & Company, lists Abracsas, Comstock and Energy XXI among those facing pressure from the upcomig redeterminations, as well as Midstates Petroleum and Swift Energy, which are in danger of delisting by the New York Stock Exchange for their low market capitalizations.

And unlike during spring redeterminations, fewer companies are well hedged this fall as many covers have rolled off and companies haven't taken on fresh positions because of the volatile market. Only 15pc of the expected 2016 output is hedged, according to research firm Tudor Pickering Holt (TPH), at an average of about \\$75/bl. Pioneer Natural Resources, EP Energy, NewField Exploration and Jones Energy are among the best hedged, with 70pc covered at \\$70/bl on average.

Still, medium to large sized producers may escape the impending redetermination largely unscathed since most of them aren't anywhere near exhausting their borrowing base. If a producer had a borrowing base of \\$500mn, for example, and it had used up only half of that, a reduction by 20pc to 30pc means that it still well within its range.

"I am not saying it is a good thing," Hammond said. "It is a bad thing to have their borrowing base re-determined lower. It does limit their flexibility, but I don't think for the bigger publics this is going to be huge life changing event."

Companies will feel the strain if oil continues to remain weak. Nymex WTI "will have a hard time getting back to \\$50 by the end of this year," said global oil and gas strategist at Macquarie, Vikas Dwidevi. "By sometime middle of next year, we will get to \\$50-\\$55."

But banks are likely to put more pressure on all producers to lower costs further, and sell assets to improve their balance sheets.

"I think the banks will have more specific plans or suggestions than maybe in the spring," PwC's Bitter said. Weak cash flows from low prices will limit their ability put cash back in to the business, and "you have a downward spiral" if producers aren't unable to generate enough cash to just keep output steady," Hammond said. "Even if prices didn't change, then your next year's cash flow is even lower."

If oil prices remain below \\$60/bl, mergers and acquisitions (M&A) activity will likely accelerate, said Roger Read at Wells Fargo. "We expect the larger and better capitalized companies to be acquirers in this unfolding environment."

ExxonMobil, Chevron, Total, BP and national oil companies may be potential acquirers. Independents with good acreage that could be targets include Chesapeake, Carrizo, Continental Resources, Oasis Petroleum and Whiting Petroleum.