Written By Sam (Yinglin) Xu and Evan Turner, Oil & Gas Investment Banking at CohnReznick Capital Markets 

Although oil prices have been falling dramatically since the end of November 2014, as a response to OPEC’s 166th Meeting, up until now, both lenders and E&P companies have been hopeful that a recovery in oil prices would allow them to avoid restructuring or refinancing their outstanding debt.  As the WTI price has fallen below $50/bbl and seems likely to remain there for the time being, both lenders and operators are now actively seeking restructuring solutions, while oil & gas investors line up the capital to take advantage.  As operators and investors continuously seek to find a “middle ground” where they can transact, many financial investors are starting to offer drilling partnerships that attempt to bridge the financing gap, instead of forcing acreage owners to sell their assets outright.

Fit for $60/bbl oil?

The following North American oil and gas operators have thus far filed for bankruptcy or bankruptcy protection since the fall of 2014: Endeavor International Corp, WBH Energy, Dune Energy, BPZ Resources, Quicksilver Resources, American Eagle Energy Corp, Duer Wagner III & Partners, Saratoga Resources, Sabine Oil & Gas, and Milagro Oil & Gas. In addition, Cal Dive International and Boomerang Tube are among the services companies that have filed for bankruptcy protection this year. Offshore rig provider Hercules Offshore Inc stated on July 23rd that they plan to file for bankruptcy protection this month. Samson Resources is among the oil and gas producers that may be close to a bankruptcy protection filing. An indicator of highly-levered companies, or those with a heavy debt burden, is the Total Debt/EBITDA or Total Debt/EBITDAX ratio, with the most vulnerable oil and gas companies with high credit risk having higher ratios, which all of the above companies have had.

As the market begins to accept the $60/bbl and under “new normal”, operators and investors alike are looking for capital solutions in order to maintain drilling plans, or simply HBP their acreage holdings.  As the public markets are being hammered and are beginning to tighten on their options for E&P companies, everyone is looking for the next private source of capital.  Although nearly every E&P company has been laying down rigs, reducing or even ceasing development activities, there is still a significant demand for capital.  Despite needing capital to avoid defaulting on their debt, many operators also require capital to continue drilling obligations that are necessary to capture and hold lease acreage positions they acquired in the past while oil prices were around $90 / bbl-$100 / bbl.
 

Increasing Asset Divestitures

One obvious way to raise capital is through asset divestitures, although now is possibly not the most opportune time.  We are beginning to see some of this type of deal flow in the marketplace. For example, Goodrich Petroleum recently sold a portion of its Eagle Ford asset for $118M, while Penn Virginia sold its East Texas asset for $75M. We expect to see more A&D activity in the latter part of 2015, increasing in 2016. However, most operators know from recent history that selling assets in profitable plays should be the last option to consider as they must forego all of the upside potential of such assets, including a recovery in commodity prices and future development.  The major problem that many operators and investors face is that sitting on a lease is not an ideal solution as non-held by production (HBP) acreage decreases in value every day due to lease expirations.

Drilling Partnership – Legacy Reserves and TPG

With many companies filing for bankruptcy protection, having strategic alternatives to explore seems to be a nice problem to have.  Last month it was announced that the operating subsidiary of Midland, Texas-based Legacy Reserves LP agreed to work with TPG Special Situations Partners on a joint drilling development of approximately 6,000 net acres that Legacy holds in the Permian Basin. Although no one structure is perfect for every company, this particular deal structure makes a lot of sense for a company like Legacy.  The drilling deal announced seems to provide Legacy with a significantly lower cost of capital with no perpetual terms and only impacts the company on the selected wellbore basis as opposed to Legacy’s entire asset base. The financing structure provides flexibility to the company and allows it to maintain its acreage stake, preserving the greater value of Legacy’s overall position. This transaction is one of several recently announced drilling partnership deals, and we expect to see many more going forward in a variety of structures.

No Perfect Solution for Everyone

While TPG is seeking a 15% return on their investment until the first reversion, we wonder whether the wells will deliver the “targeted” returns at current oil pricing.  If TPG can obtain its stated return in this transaction, then, given that most operators believe they can realistically achieve these returns on a single-well economic basis, it would appear that this structure would work for many low-cost operators in many premier basins.  However, we are maintaining a “wait and see” position on this.

Final Thoughts

Many questions have yet to be answered, but, as always, we strongly believe that the US energy industry is self-correcting and perfectly capable of generating substantial returns over time for prudent operators and investors alike.  This downfall is creating a lot of opportunities to investors, especially for Private Equity and bondholders. There has been a large influx of capital in the energy space, and much more capital has yet to be deployed. To be able to participate as well as compete in this industry, investors have to be more creative and flexible in their investment strategies. Since no one can accurately predict the future oil prices, maintaining the long-term view is significantly important at this time.

About CohnReznick Capital Markets Securities, LLC
CohnReznick Cap Markets is a boutique investment bank that focuses on providing companies, institutional investors, and family offices with a full suite of investment banking advisory services. Founded in 2008, and led by President and Founder, Rob Sternthal, the company specializes in structured equity, project finance, M&A, and restructuring across multiple industries. As a wholly-owned subsidiary of CohnReznick LLP, a national accounting, tax, and advisory firm in the United States, CohnReznick Cap Markets leverages its parent company’s expertise and vast network of clients.
To date, CohnReznick Cap Markets has secured financing for more than $5 billion in assets and transacted nearly $500 million in buy-side and sell-side asset sales and M&A. While these transactions have primarily been in the renewable energy industry, we also have significant transaction experience in structured finance, oil & gas, middle market companies, and special situations. CohnReznick Cap Markets approaches every transaction with a client-centric philosophy aimed at building and sustaining relationships rooted in integrity, expertise, and market insight.
CohnReznick Cap Markets’ mission is to provide its investors with opportunities that command attractive returns and long-term value. The Firm is regulated by the Financial Industry Regulatory Authority (FINRA).

http://www.cohnreznickcapmarkets.com/

Sam (Yinglin) Xu, Director

Direct: (917) 472-1300

Email: Sam.Xu@CRCMS.com

Evan Turner, Associate

Direct: (917) 472-1305

Email: Evan.Turner@CRCMS. com