If you were looking to get up to speed on the unique aspects of restructurings for Exploration & Production companies in the oil and gas sector, you missed a great event last night with Akin Gump’s “Exploration & Production of an Oil & Gas Restructuring” in New York. Moderated by New York restructuring partner Ira Dizengoff, with a panel roster comprised of their heaviest hitters for oil and gas company representation, and some special guests, attendees were given access to a wide spectrum of expertise in all things pertinent to chapter 11 filings, out-of-court workouts, and investment considerations for our current period of market turmoil.
The first half of the presentation focused on “The market snapshot and the capital markets’ response,” beginning with some basic facts and figures. World aggregate production of oil, including all conventional and unconventional sources, has been about 93 million barrels a day, but consumption is only at about 91.5 mbpd. Thus, we are overproducing by a whopping 1.5 mbpd, causing storage levels to push the needle far beyond the norm. A strong dollar has also contributed to downward pressure on prices.
As expected and hoped for, prices have shown a technical correction and bounced back favorably over the last 6 weeks, currently closing in on the $65 per barrel level that J.P. Hanson of Houlihan Lokey (Managing Director and Head of E&P Practice) explained was the approximate going forward market price that oil and gas company debt traders are projecting. Equity traders, whose timelines are longer, are currently assuming an $85 – $90 price.
But for Hanson, the biggest vote of confidence in the sector’s future can be seen in the huge amounts of capital already going into the space, or standing by and itching to get in at the right level of value. Indeed, this was a theme throughout the evening’s discussions, and is consistent with prior reporting on this site, although as we learned from some lively exchanges between Hanson and other Akin Gump attorneys in this first session—Chip Cowell and Gabriel Procaccini (partners in Global Energy & Transactions)—there remains a substantial disconnect between what buyers are willing to pay for assets and what sellers are willing to accept. In other words, a lot of money is on the sidelines waiting for sellers to get more desperate (“realistic,” as Hanson would put it).
Also at issue for buyers is the reluctance to jump in on the mostly lower quality assets that make up this first round of sell-offs (the plays that are more speculative or difficult to extract). Buyers will be more interested when more higher quality assets are added to the mix.
Mr. Dizengoff raised the question of why the April round of credit resets does not seem to have had as large of an impact as many had expected (those “revolver raids” which we described in our prior article here ). The answer, offered by Michael Stamer of the Akin Gump New York office (Partner, Financial Restructuring) is, quite simply, that banks have shown leniency. Except in instances like Sabine, in which the company was over-levered beyond help, banks have chosen to sit tight and not be so quick to pull the trigger, knowing well that such hastiness might unnecessarily turn a bad situation into something much worse. However, if we head into fall stagnating in these depressed prices, you can be sure that the leniency will start to give way and we will see some aggressive reductions in credit lines.
As the conversation moved into issues that senior secured noteholders need to be aware of, Akin Gump’s expertise really began to shine. Chip Cowell went through a checklist of items, including the important fact that a not uncommon feature of existing indentures for oil & gas companies can actually prohibit the taking on of new debt if year-end accounting figures do not meet a threshold, and thus money available by willing lenders may not even be accessible to some if oil market prices remain in the gutter. He also pointed out the oft forgotten failsafe that allows E&P companies to refinance unsecured notes with new secured debt.
Gabriel Procaccini, from the Houston office, closed the opening session by pointing out the wide disparity in some of the break-even costs, which can range from as low as $35 per barrel up to $65 and higher (e.g. Cana-Woodford in Oklahoma). He also recommended getting all the facts about the specific states you are interested in, such as the priority rights afforded to unpaid royalties in Louisiana, since there are different laws and regulations in each state that come into play and require another level of analysis on top of everything else one must consider.
Those who came out to the event hoping to learn some valuable details about chapter 11s and out-of-court restructurings were far from disappointed by the second half of the program. Akin Gump partner Sarah Schultz (Financial Restructuring, Dallas office) led off with some eye-opening revelations about the various types of assets that E&P companies generally maintain as unencumbered—i.e., they are not part of the collateral base in secured lender obligations. This includes undeveloped reserves and even a percentage portion of proven reserves. She strongly suggested that interested parties read all the available documents and public filings, because you’ll be surprised to learn what assets remain unencumbered.
In a chapter 11 context, these unencumbered assets are a significant issue for unsecured creditors, since they fall outside of the priority domain of secured creditors. That’s certainly good news for the general unsecureds, who with the typical over-levered chapter 11 debtor are left to scramble over crumbs.
Ms. Schultz also walked the attendees through the standard industry accounting practices that pose unique challenges to the standard bankruptcy process. At any given time, a debtor will typically be holding a certain amount of cash that belongs to others and is therefore not estate property. This has to be reconciled before a clear idea of cash assets can be determined. Receivables are also not so readily allocable, as it can take over 9 weeks after a product sale for the cash to come back in and then be allocated between royalties, operating costs, and the various encumbered and unencumbered assets. Phil Dublin of the New York office (Partner, Financial Restructuring) pointed out how these accounting issues also make DIP agreements a tricky process in which the right balance must be struck for allocations between parents and various subs in the corporate structure, often leading to intercompany DIP arrangements.
A number of additional items for the chapter 11 checklist were also presented. Dublin pointed out how there are some types of claims specific to E&P, such as mineral lien claims, which are crucial to ongoing operations and should be included in motions for receiving critical vendor treatment in order to preserve the debtor’s operating capabilities. Steven Davis of the Houston office (Partner, Global Energy and Transactions) expounded on all of the intricacies of leasehold interests for drilling lands, and cautioned that parties trying to take control of the debtor will want to recharacterize leasehold interests as real property interests in order to obtain the benefits of such characterization under bankruptcy law (and on that point, investors should take care to find out whether leasehold interests are regarded as executory contracts or real property interests in the various states that concern them). Dizengoff offered his own warning to secured creditors to take care to obtain 506(c) waivers so that they are not stuck footing the bill for expensive collateral maintenance costs.
Looking forward, Thane Carlston of Moelis & Company (Co-Head of the Recapitalization & Restructuring Group) predicted that mergers in the sector with going concerns will be popular, as will rights offerings. Valuations should be fairly easy to agree on with respect to proven reserves, but disputes will abound regarding the unproven. Carlston also expects bankruptcy judges to hold to conservative estimates, or at least “conventional wisdom,” with respect to future oil prices and will likely reject any valuations that fall outside of that norm, no matter what fancy arguments are provided in support.
Another unusual component of chapter 11 proceedings for E&P companies is that debtors will seek approval to conduct further exploratory work. You generally don’t see debtors pleading the court to allow them to spend large chunks of money with an acknowledged risk that the investment may not yield any recoveries—but then again, that is the nature of the business. There is no production without exploration—the “E” comes before the “P.”
Concluding the event, the panel predicted sale approaches from a “sum of the parts worth more than the whole” perspective, and a favor for out-of-court restructurings in order to avoid the higher cost of formal bankruptcy filing and the risk of complications that may arise post-filing. With lots of different creditor constituencies, detailed advanced planning for different possible outcomes will benefit both filing and non-filing companies. And if a company does have to file, don’t make assumptions about venues, but look carefully at applicable case law and the predictability factor regarding the most pertinent issues to the filing company.
It was clearly a well-spent evening, with a happy crowd (accustomed to such events providing an “ok, that may be useful one day” feeling) leaving the Eventi Hotel satisfied that they are much better equipped now to deal with issues that are of immediate concern regarding the many distressed oil & gas companies in the field.
The editors and editorial board of DailyDAC include preeminent restructuring and insolvency professionals, journalists, and editors. They are devoted to providing reliable and plain English education and deal intelligence about assignments, corporate bankruptcy, receiverships, out-of-court workouts an similar topics.
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