Rob Lindermanis,
managing director of Petrobridge Investment
Management LLC. Petro Resources Corp.

Mezzanine debt providers in energy say they have largely avoided the debt crisis that has crippled other areas of the capital markets in the past few months. Firms dedicated to mezzanine debt predict the 2008 market will remain competitive and robust for oil and gas companies.

GasRock Capital LLC, Guggenheim Partners, NGP Capital Resources, Petrobridge Investment Management and Prospect Capital were canvassed. None expect to see a slowdown in mezzanine funding. They believe the upstream sector will continue to provide good returns for investors.

That said, however, all believe the mezz market will continue to be competitive in 2008. “We know there are cycles within the capital markets,” says Rob Lindermanis, managing director of Petrobridge Investment Management LLC.

“But our group has been involved in capital providing for a long time and has done it under the Petrobridge banner since April 2003.”

Since its formation, Petrobridge has closed 29 transactions with capital commitments of $850 million. In 2007, it invested more than $225 million and completed five transactions, its largest investment in a year.

“We saw a great deal of interest in mezzanine financing and continue to see a good pipeline of potential business today,” Lindermanis says. “We think, as long as companies want to retain or preserve equity ownership, our structures will have a role to play in the capital markets.”

The debt crisis has not affected the energy capital markets, he says. “We anticipate this will continue in 2008 and the oil and gas industry will provide attractive returns to the investment community.”

In February 2007, Petrobridge provided Petro Resources Corp. with a $75-million senior secured credit facility to acquire and develop assets in North Dakota. The company had an initial availability of $32 million to focus on its Williston Basin program. “Petro Resources was able to ramp up their program, which allowed them to go back to the market and do a $28-million equity offering,” he says. “Petrobridge continues to play a capital-provider role with the company to support their growth and expansion.”

Wayne Hall, chief executive of Petro Resources, says the Petrobridge financing was an excellent option based on the company’s capital structure, the nature of its enhanced oil-recovery project acquisition, and the timing of closing the acquisition.

In April 2007, Petrobridge also provided Baseline Oil & Gas Corp. with a $75-million senior secured credit facility to acquire and develop assets in Texas and Indiana. Petrobridge advanced Baseline $33 million to acquire a North Texas asset, drill wells and use bridge dollars toward a sizeable subsequent acquisition. The lattermost helped the producer lock up that asset, Lindermanis says.

“The company was able to then go out and raise a $165-million note, which resulted in an exit for Petrobridge,” Lindermanis adds. “During those seven months, the company was able to execute a significant acquisition and development program.” John Homier, president and chief executive of NGP Capital Resources Co., expects the mezzanine market to remain active in 2008 as energy companies continue to need capital to develop projects and accelerate growth.

During the past three years, NGP Capital Resources has made $490 million in energy investments and had realizations of $218 million, resulting in a present portfolio of?$272 million. The publicly traded firm has grown its portfolio by between $90- and $100 million annually by investing largely in small-cap private energy companies.

“Our view of the market is that we can continue at that pace or slightly faster in 2008,” Homier says. “I think the market is going to continue to be active because there are still many companies that have high-growth and high rate-of-return projects that need capital. I believe 2008 will continue to be a good year, if not a growing year.”

In 2007, NGP Capital made seven new investments and seven add-on investments providing $235 million in availability to its clients. It also had realizations of $107 million, which net $128 million of growth.

Core energy mezzanine-capital providers have not been affected by the current debt crisis, Homier says. “There is nothing I can see that would cause the capital flows from the consistent mezzanine energy players to diminish. We’re still waiting for the other shoe to drop as it affects the noncore players that have come into the market in the past three to five years.

“Some impact is there already. An example is the second-lien or Term B market, which has seen terms change, including wider spreads of 200 to 300 basis points, tighter covenants and structure. But, the entire effect on availability of funding has yet to be fully understood and appreciated. We’re still in an evolving environment.”

In May 2006, NGP Capital provided Torch Energy Advisors Inc. with a $95-million facility that included an $85-million senior debt facility and a $10-million convertible debt facility. The funding allowed Torch Energy to form Resaca Exploitation LP to acquire the assets of SDG Resources in Texas.

“They seemed to have the best fit,” says Jay Lendrum, president of Torch Energy Advisors. “We felt very comfortable working with NGP and it maximized the value for both them and us.”

Homier says Resaca has made great progress at developing assets, increasing production, and setting the stage for future growth and production.

Prospects, opportunities Dave Belzer, managing director and head of oil and gas investments for Prospect Capital Corp., also believes 2008 will contain lots of potential.

“Attractive opportunities in the oil and gas sector present themselves,” he says. “We continue to seek seasoned management teams with high-quality proved reserve assets that are seeking significant development capital.”

In 2007, Prospect closed more than a dozen deals in the energy industry, including a substantial number upstream. The first quarter of 2008 has kicked off in “a busy fashion,” Belzer says. He believes activity will not slow in 2008, so long as the current commodity-price environment remains high by historic standards.

Mezzanine capital continues to be an attractive alternative for energy companies seeking development capital for a number of reasons, including mezzanine’s greater advance rate against proved reserves, minimal equity dilution and maintenance of managerial control.

“We’re advancing capital at levels that help borrowers fulfill their business plans, for reasons such as accelerating their drilling programs, completing acquisitions or restructuring balance sheets,” Belzer says. “Mezzanine capital is an attractive option because it allows the companies to manage their operations with autonomy.”

In July 2007, Prospect Capital provided a $45-million senior secured facility to H&M Oil and Gas LLC. The facility was used to refinance the company’s senior borrower and to fund additional drilling costs for H&M’s Spraberry-Wolfcamp play in West Texas.

Bill Jackson, general manager of H&M, says the funding has allowed the company to double the number of wells and triple production. A portion of the facility also replaced the company’s existing bank debt.

“Historically, we had gone through commercial banks, but they are limited in what they can finance,” Jackson says. “We felt the need to accelerate our development growth in the Spraberry/Dean/Wolfcamp on the Holt Ranch in Martin County, Texas. In the environment that we are in right now in, it’s important to get wells online as fast as possible.”

Prospect Capital understood this and created a structure it and H&M could live with, he adds. “It allowed us to go forward with our drilling program in a much more aggressive mode.”

Like his peers, Lynn Bass, a principal and co-founder of GasRock Capital LLC, also expects an increase in the number of companies using mezzanine capital in 2008. In 2007, GasRock Capital closed seven transactions for a total of $387 million. The energy sector has been shielded from the market downturn and has seen little pullback, Bass says.

“M&A activity should be robust, especially for transactions under $250 million as more medium- to large-size energy companies seek divestitures to free up capital to focus on their core areas,” Bass says.

Service costs are falling and producers are able to hedge production at attractive prices. “It appears that energy is still viewed as a bright spot, a safe place for investors. For focused energy funds like us, there is very little change.”

In July 2007, GasRock provided a $75-million senior debt facility to Two Oaks Exploration and Production Co. LLC. The facility, in part, allowed Two Oaks (and related entities) to redeem certain ownership interests, resulting in one of its owners, Robert Millard II, becoming the majority owner.

Two Oaks has assets in Andrews, Reeves and Midland counties in West Texas and is operated by Pacesetter Energy Inc., a private company with teams dedicated to developing and operating upstream, midstream and oilfield-services businesses. “The management team was very committed to the project,” Bass says. “There was a nice blend of assets with a mature field, refracs and recompletions. This was a very compelling investment.”

Luis Moya, Pacesetter chief financial officer, says the senior debt facility was used?to?recapitalize?Two Oaks, buy out certain working interests and accelerate its development plan.

“Mezzanine capital?is allowing?us to grow?Two Oaks faster than we could?if we relied solely on a revolving credit facility from a commercial bank, without the dilutive effect of selling equity?to obtain growth capital,” he says.

Two Oaks?received the capital within three weeks of beginning?the loan documentation process, another positive outcome, he adds. “It was an extremely positive and timely process. They are just a nimble firm.?GasRock is?able to move on a deal when the borrower is ready.”

Deal flow Tim Murray, managing director of Guggenheim Partners, says in the mezzanine space, he’s seen no slowdown in deal flow. In 2007, the firm closed 15 transactions, with the majority consisting of mezzanine deals with some equity sprinkled in. “We expect to see more of the same, which is robust deal flow driven by continued strong commodity prices and available capital,” he says. “Debt pricing has increased and some institutional players have dropped out. The institutional players I’m referring to are generally funds that have some liquidity issues due to the credit crisis, or have capital that is subject to mark-to-market (derivatives) influences.

“There are very few institutions pulling back from energy due to poor (energy) investments or lack of confidence in the industry. If gas prices fall due to the historically high storage levels, that could moderate the demand for capital targeted for some of the marginal gas plays.”

Guggenheim agented a transaction involving Ram Energy Resources Inc. in 2007. Ram is an Oklahoma oil and gas company whose properties are primarily in Texas, Louisiana and Oklahoma and is listed on Nasdaq.

In November 2007, Ram acquired Ascent Energy, a privately held Texas company, for $286 million, which included $190 million in cash and the issuance of 18.5 million shares of Ram stock.

Ram received a $175-million senior secured revolving credit facility and a $200-million senior secured Term B facility from a group of lenders led by Guggenheim to complete the Ascent acquisition.

“The Term B loan was oversubscribed to $450 million, and the lenders for the existing revolver increased their commitment from $100 million to $175 million.

Larry Lee, Ram chairman and CEO, says, “At the time, there was turmoil in the marketplace. The Ascent acquisition almost doubled the size of company. We paid higher interest rates on the Term B facility, but I think that was a reasonable price for us to pay to get the transaction we had negotiated and had captured.”

Ram grew from approximately 20 million barrels of proved reserves to approximately 40 million and 110,000 net acres of leasehold, including a majority in desirable shale plays, including 47,000 acres in West Virginia and 27,000 acres in the Barnett shale, with the remainder in conventional oil and gas in Oklahoma and Texas.

“Mezzanine debt is a good financing source,” Lee says. “We were pushing the envelope a little bit as we added more leverage; however our lenders were receptive. We have been evaluating our assets and will bring in additional capital by divesting some non-strategic assets, and we are considering putting some assets into a portfolio attractive for an MLP.”