Independents should have little trouble reaching into the deep pockets of the nation's commercial and investment bankers to fund projects for growth, according to Tim Murray, executive vice president and manager of the energy group at Wells Fargo. He spoke at the recent Independent Petroleum Association of America (IPAA) 75th anniversary meeting recently, and put in a plug for his segment of the finance industry. "If capital is the lifeblood of independents, commercial banks are the heart," he said. Those banks have provided 65% of the financing for oil and gas. Among Houston energy banks, the oil-price deck on which loan value is based is $26.52 per barrel this year, and at $24 in 2008-a considerable discount to the Nymex strip of between $30 and $38 a barrel. "If you subtract terrorists and turmoil, there's about a $6 difference," Murray said. That leaves a 20% price-swing cushion, which he called "reasonable." That's the price at which banks feel comfortable with the reserve-backed loans they're making. For natural gas, the strip is $6.37 per million Btu now, moving to $5.14 in 2008. The bank lending range in the same period drops from $4.16 to $3.70. That still leaves a 28% cushion after the terrorist and turmoil discount, Murray said, but gas is more volatile than oil. With interest rates at a 40-year low and the economy improving, "this is a good time to look into low rates," he added. As for the sources of the $678 billion in capital that has been supplied to the energy industry, public equity provided 15% and private equity, less than 1%, he said; debt accounted for 86% and commercial banks supplied about half of that figure. On the upstream side, private equity supplied 4%; public equity, 8%; and debt, 88%. Banks provided 66% of the total debt. During the years when public markets aren't favorable, mezzanine financing and private equity step in to fill the gap, Murray said. Now, record quantities of private equity capital are available. With low interest rates and high commodity prices, all of Murray's clients are paying down debt today from high cash flows. He also has seen a lot of volumetric production payment deals and calls those arrangements "a great vehicle to monetize reserves but retain control." Investment banks are in the market in a big way, he added. The top three investment banks participated in 80% of investment-grade commercial loans. Looking back at companies levered 2.5 times in 1997, their loan rates typically were 150 points over Libor (the London interbank offered rate). In 2003, those loans commanded a 250-point premium over Libor, he said. BBB+ loans for oil and gas rose only 12 basis points from 2001 to 2003, which means the financial markets haven't attached much of a risk premium on oil and gas operations. If oil and gas exploration is considered a risky business, it seems strange that banks are so aggressive in looking to the industry to place their money, but a 2002 Standard & Poor's report showed that less than 1% of loans to oil and gas companies between 1995 and 2002 were in default and nearly 100% of the money was recovered. Among commercial bank loans to producers, Murray said, JP Morgan Chase leads with a 45% share, while Bank of America and FleetBoston claim 16%. Borrowers could see underwriting fees increase as bank mergers reduce competition, he added, but regional banks should step in to take over the lost lending capacity. Relative to banks, the mezzanine finance segment takes a little higher risk but expects a lot higher return. Typically, the return for wildcat drilling should be 45% to 50%, equity-linked securities look for returns upward of 25%, project equity could be as high as 45%, development loans and mezzanine debt should get returns to 20% and bank loans currently are made for less than 10%, he said. -Don Lyle