The recent drop in oil prices, which has almost wiped out the price gains since OPEC announced its supply-cut deal, is coming just ahead of the spring season when banks are reassessing the credit lines they are extending to support drillers’ growth plans.
WTI front-month futures have been trading below $50 a barrel for a couple of weeks, while Brent crude slipped briefly below $50 on March 22, dropping below that psychological threshold for the first time since November 30, the day on which OPEC said it agreed to curtail collective oil production in an effort to rebalance the market and lift prices.
Lenders review the oil and gas companies’ creditworthiness twice a year, in April and in October, in the so-called borrowing base redetermination. The recent drop in the price of oil may prompt banks to be more cautious in their assessments, but still, things look brighter for oil firms than they did in March last year when oil prices were consistently below $40 a barrel.
This time around, analysts expect reductions in credit lines should oil prices drop below $45 until creditworthiness reviews are over, according to Bloomberg.
These assessments are closely connected to the price of oil, given the fact that the value of the companies’ oil and gas reserves serve as the basis for their creditworthiness assumptions.
Nonetheless, reviews are less likely to lead to drastic credit cuts this spring because the companies that have survived the oil price crash have emerged leaner after major cost cuts, asset sales, and focus shifting to easier, cheaper, and more lucrative areas, such as the Permian. U.S. shale players have been locking in future production, and the best drilling areas are now estimated to be profitable at as low a price as $40 per barrel.
For last year’s spring borrowing base redetermination season, Houston-based law firm Haynes and Boone said in a survey prior to the reviews that energy lenders and borrowers were largely expecting the ability to borrow against reserves to be significantly decreased by an average of more than 30 percent. Haynes and Boone’s spring 2016 survey showed that 79 percent of respondents expected borrowers to see their bases decline, up from 68 percent in the spring of 2015.
In the fall 2016 survey ahead of the latest borrowing reassessment this past October, Haynes and Boone said that respondents on average expected 41 percent of the borrowers to see a decrease. This decrease was expected at an average of 20 percent, in which lenders were expecting a 16-percent decrease and borrowers a 29-percent decrease.
So, ahead of the latest survey, bankers were decisively more optimistic than E&P borrowers were. According to Haynes and Boone’s press release, this could have been an indication that “exploration and production companies themselves are more pessimistic as they see their reserves more realistically with sustained low commodity prices likely.”
However, the fall 2016 survey also showed that respondents did not see traditional banks as the biggest capital providers over the next 12 months. Private equity firms and high-yield private debt entities were expected to play the major roles in funding, with 57 percent of respondents pointing to this. Just 14 percent expected traditional banks to be one of the two top sources of capital, Haynes and Boone said.
According to Wood Mackenzie, 118 oil and gas companies that have announced 2017 budgets are planning to spend a combined $25 billion more than they did last year, or 11 percent more than in 2016. Some majors and internationally focused firms are still planning budget cuts amid capital discipline, but U.S.-focused companies are expected to account for $15 billion of the $25-billion increase in spending, WoodMac said.
The price of oil will surely be the major component in banks’ reviews of borrowing bases. Still, decreases are not expected to be as drastic as they were at the height of the oil price slump.