A glut of natural gas continues to weigh down prices. In response, some operators have started monetizing their in-the-money hedges to raise capital. Others are facing adjustments to their borrowing bases and may be forced to sell assets at a time when prices are low. Still other operators are in Chapter 11, or may be headed that way, and face distressed sales.

“We may see significant strain this fall in terms of those adjustments,” says Nir Yarden, a partner at Haynes and Boone LLP. “There are opportunities to acquire gas reserves at historically low valuations.”

Natural gas operators in this situation face unpleasant choices: they can put themselves up for sale, they may seek additional equity investment, mezzanine debt or may have to seek Chapter 11 bankruptcy from creditors, Yarden says.

Haynes and Boone sponsored a recent webinar to discuss the problems caused by lower natural gas prices as well as the opportunities that a distressed sale may bring. Two other partners urged shoppers looking for natural gas assets at bargain-basement prices to exercise caution.

Charles Beckham and Kenric Kattner, both specialists in bankruptcy law, say buyers should consider the possibility that unsecured creditors may challenge the transaction years later as a fraudulent transfer. If successful, the move could leave a bargain shopper without the assets and nothing but an unsecured claim against an insolvent seller.

In order to meet capital obligations, some natural gas companies are forced to sell reserves at a time when gas prices are near record lows, a practice which has created a buyer’s market for distressed natural gas assets.

While low gas prices may pose challenges for some operators, they provide opportunities for opportunistic buyers.

To complicate the process for operators, hedges may no longer soften the blow to the borrowing base. If, for example, a hedge is in the money from September 2012 to March 2013, it won’t do anything to protect the base. Only hedges after that point affect the working capital borrowing base. Although many producers have successfully hedged the risk of weak prices, many of these hedges are starting to expire and they are unable to replace them at attractive prices.

Beckham and Kattner advise buyers of distressed natural gas assets that the easiest way to avoid a fraudulent transfer claim is to pay reasonably equivalent value for the asset. Beckham says the current market may be similar to previous booms and busts seen in the energy industry over the last 30 years. “The current promise of all gas production has caused a frenzy in some shale plays. …. It’s hard to predict whether what we are seeing right now will result in a great bust,” he says.

But the prolonged distress in natural gas prices could foretell another bust.

In many cases, Beckham says natural gas operators are obligated to continue to drill to maintain the lease. They cannot drill themselves out of the problem because the drilling costs often exceed the incremental revenue from the additional gas, he says.

In other cases, Beckham says he has seen some producers who wanted to tie up rigs in long-term commitments when prices were stronger and forecasts expected them to hold. As prices have fallen, these producers find themselves tied into long-term commitments for rigs at a time when natural gas prices don’t justify their costs.

Haynes and Boone also advised potential natural gas buyers to avoid the perception of sweetheart deals when shopping for natural gas assets. Insider relationships can be all-too common in many oil & gas contexts. A corporation, its affiliate corporations, the officers and directors of either, and certain shareholders may all be insiders of each other. As a result, transactions between them will likely receive additional scrutiny from creditors.

The panelists urged operators to consider the risk of a subsequent lawsuit on the grounds of fraudulent transfer from the perspective of the seller’s creditors. Does the transaction look like an arm’s length transaction for reasonably equivalent value? Concealed transactions are more likely to raise suspicion than transparent ones. For example, a competitive public sale process is far less likely to be scrutinized for fraudulent conduct, even in today’s economic environment where no competing bidders may participate, according to a recent white paper prepared by Haynes and Boone.

Beckham advised that in some cases acquiring natural gas assets through a Chapter 11 bankruptcy may give the buyer some protections it would not otherwise have outside of a bankruptcy sale.

In addition to the lower risk of fraudulent transfer claims, Chapter 11 has other benefits for potential buyers. An asset sale is free and clear of liens in Chapter 11. In many transactions outside of bankruptcy, there is no mechanism to discharge liens. A sale free and clear can clarify this and provide more comfort to a buyer. Chapter 11 also allows all parties to assign contracts more easily and to resolve title issues as well. Finally, the process allows operators to cherry-pick distressed assets which fit in with a buyer’s existing portfolio of assets.