?Liquidity, previous hedging, low debt, declining costs and capital-spending discipline are among the key features of a strongly positioned E&P, according to Jeff Morrison, associate director of corporate and government ratings, with Standard & Poor’s debt-rating service. Also key is the E&P’s use of asset sales to further bolster the balance sheet.
The attributes Morrison cites are mitigating factors against declining commodity prices, reduced access to debt or equity capital, upcoming borrowing-base redeterminations, covenant violations and overspending cash flow.
Morrison made his observations recently in a webinar, “Seeing Through To Solutions: The Economic Downturn’s Impact On The Energy Industry,” which was hosted by OilandGasInvestor.com.
“Cash-flow adequacy is an area in this market we are certainly focusing on now,” Morrison said. Among the 44 E&Ps whose credit quality S&P rates, one is rated “A” and 30 are rated “BB” through “B-,” or generally in the high-yield category. S&P’s analysts have issued 15 negative high-yield E&P rating actions so far this year.
“Liquidity is something we’re really placing a premium on right now.”
Greg Kerley, executive vice president and chief financial officer for Houston-based Southwestern Energy Co., offered his company’s current financials as a baseline example of a well-positioned E&P. “We are a bit of an anomaly in that we don’t have borrowing-base redeterminations…through 2012,” Kerley said. Its $1-billion credit facility is unsecured, and is undrawn.
The Fayetteville-shale-focused producer has some $200 million of cash on hand. Its $600 million of senior notes are at 7.5% and are not due until 2018, and its year-end 2008 debt-to-total-capitalization ratio is expected to be some 23%. The company has put no new production hedges in place, and the remaining hedges—approximately 48% of its 2009 production—are at an average floor of $8.48 per thousand cubic feet. By operating about 90% of its production, its can control spending, up and down, he added.
Michael D. Bodino, director of research and senior E&P analyst for the SMH Capital institutional equity research group, suggests that investors seeking clues to the best-positioned E&Ps in a total-downturn marketplace should keep sight of red flags. “There are a number of companies that are precariously positioned. Watch for the following warning signs that keep us up at night.”
• Spending more than cash flow or having to make a sizeable investment to convert a project to cash flow. These E&Ps may still be drawing down a borrowing base. “Those that have to borrow give us the most concern into this downturn.”
• No dry powder. Poor project economics. These E&Ps may be continuing to pursue projects with mediocre or poor rates of return.
• High debt-to-cap and high debt-to-EBITDA. Difficult capital structures and/or unpalatable terms in bond indentures or bank covenants. High G&A as a percentage of revenue. High F&D costs and poor investment returns.
• Positioning in the wrong basins, e.g. the Rockies or Gulf of Mexico. “Gulf of Mexico companies need 70% to 80% of cash flow to replace reserves.”
• A short reserve life, which is a higher risk in a period of declining commodity prices.
• A high percentage of PUDs (proved, undeveloped reserves). “You start getting an aging-of-PUDs issue where you can’t develop them in a period of time in which they are valuable.”
• Long acreage and short capital. “Don’t be fooled.”
• Negative growth rates, as shrinking companies typically mean shrinking capital and smaller valuations.
Solutions include refinancing; monetizations, including VPPs, farm-outs and joint ventures; strict cost management and at worse, a merger or sale. “I certainly expect to see more M&A activity this year,” he said.
“The silver lining? The average (commodity-price) down-cycle since 1970 has lasted an average of 18 months…The next upturn begins again in earnest in 2018.
Recommended Reading
Chesapeake-Southwestern Deal Delayed Amid Feds Scrutiny of E&P M&A
2024-04-05 - The Federal Trade Commission asked Chesapeake and Southwestern for more information about their $7.4 billion merger — triggering an automatic 30-day waiting period as the agency intensifies scrutiny of E&P deals.
FTC Strikes Again: Diamondback’s $26B Endeavor Merger Delayed
2024-04-30 - Diamondback Energy, which was nearing the end of a regulatory review period of its merger with Endeavor Energy Resources, is the latest E&P to see a deal postponed by the Federal Trade Commission.
Chord, Enerplus’ $4B Deal Clears Antitrust Hurdle Amid FTC Scrutiny
2024-04-08 - Chord Energy and Enerplus Corp.’s $4 billion deal is moving forward as deals by Chesapeake, Exxon Mobil and Chevron experience delays from the Federal Trade Commission’s requests for more information.
FTC OKs Exxon-Pioneer Merger, but Bars Sheffield from Exxon’s Board
2024-05-02 - A megamerger between Exxon Mobil and Pioneer Natural Resources can proceed, but Pioneer Chairman Scott Sheffield is out, the Federal Trade Commission says.
Stice: Diamondback’s Small Company Culture Suits Big M&A Appetite
2024-05-01 - Diamondback Energy CEO Travis Stice tells analysts that the company’s nimble nature is among its top qualities, allowing for rapid growth and the successful integration of Endeavor Energy this year.