Among new financing sources that have emerged during the challenging times of the last few years for oil and gas producers are credit funds, which are lenders but not typical big box banks. These lenders tend to focus on more specific company profiles rather than try to service entire sectors. Credit funds absorbed a portion of the market share for senior secured loans when borrowers and institutional lenders dried up. Many such non-traditional lenders were successful in identifying high-performing borrowers that were being unreasonably hampered by general market sentiment.
Another new source of capital involves securitizations of producing wells. By bundling many different oil and gas producing assets and hedging price exposure, these structures can achieve investment-grade ratings for notes secured by oil and gas assets, and they attract a new investor class. Presidio Petroleum of Fort Worth, Diversified Energy of Birmingham, Ala., and PureWest of Denver have all recently announced securitization transactions.
This new product has become a useful tool to replace all or a portion of an existing loan from a traditional big box bank. Securitizations also frequently provide enough proceeds to fund growth or pay dividends to shareholders. In addition, these companies reap the benefits of any improvement in performance or unhedged pricing from the securitized assets.
Cash (flow) is king
One common theme, however, both from traditional sources of capital and from new entrants has been a focus on free cash flow — cash after expenses and a demand for more discipline in producing excess cash. Independent producers have heard the message and clearly understood the assignment. Many public companies have cleaned up their balance sheets to generate more cash, and, in many cases, to pay shareholder dividends.
At the same time, many oil and gas companies have been able to raise investments by issuing rated notes and bonds, while not being investment grade issuers. Although the investor appetite for these products has been off-and-on this year, the companies with the strongest balance sheets have been able to raise funds with these products.
Now, with rising commodity prices and most producers’ recent results showing lower costs and greater cash flow, many traditional sources of capital are returning to the sector. Reserve-based lending by banks and other traditional institutions — credit based on proved oil and gas reserves — has rebounded in recent months, and high-yield issuances have been robust for financially responsible producers over the last few quarters.
Meanwhile, the new and creative capital solutions remain available. These non-traditional lenders continue to be opportunistic, and securitization structures are becoming more common and easier to execute. At the same time, investments in public oil and gas companies have been performing well the past few quarters, driven by sound fundamentals and rising prices. For the moment, however brief, the outlook seems far better than it has in a few years.
Daniel Allison is an energy and global finance lawyer in the Houston office of Sidley Austin LLP.