E?­­ach morning this fall has brought news of further financial-markets distress and failure. Capital providers and users don’t expect to have already seen the last of it; instead, they expect this is just the beginning of more market shake-out.


Capital providers to U.S. independents that had fallen at press time include Bear Stearns Cos. Inc. (purchased by JPMorgan Chase & Co.), Merrill Lynch & Co. (purchased by Bank of America), Lehman Brothers (U.S. operations sold to London-based Barclays Capital; European and Asian divisions sold to Japan-based Nomura Holdings Inc.), Washington Mutual (sold to JPMorgan Chase) and Wachovia Bank (sold to Wells Fargo).


To shore up stalwart Goldman Sachs, whose stock price was being pulled down with those of other investment banks, Warren Buffett’s Berkshire Hathaway invested $5 billion.


While the Bear Stearns event was a precursor this spring, Merrill and Lehman tumbled in mid-September, and Wachovia and WaMu fell two weeks later. And, all of this has been occurring in the midst of falling oil and natural gas prices, further constraining producers’ access to capital and to hedging.


“As Hurricane Ike was approaching Houston, there was a hurricane approaching 25,000 employees at Lehman Brothers,” says Brad Hutchinson, formerly of the Houston energy office of Lehman and now managing director at Barclays Capital, still in Houston.


Operations purchased by Barclays include U.S. investment banking, sales and trading and most retail brokerage units, which support equity issuances on the retail side and the firm’s master limited partnership franchise. Among the 25,000 Lehman employees, some 10,000 were retained.


“I think we can all agree we are living in historic times,” Hutchinson says. “How we got here is relevant, but we need to deal with the problem at hand. The plumbing of finance—not just in the U.S. markets but globally—is clogged. And it’s clogged like we haven’t seen it in a number of years.”


Greg Pipkin, a long-time E&P financier and another new Barclays managing director by way of Lehman, advises, “Start-ups should look for capital from people with whom they have a strong relationship. In a market like we are in today, capital is scarce. Relationships with strong institutions are needed to see an E&P through its business plan, whether three years or 10 years.”


Tom Pritchard, managing partner and founder of Mandeville, Louisiana-based Pritchard Capital Partners LLC, says the pressure on debt markets is triggering capacity issues in the oilfield-services sector. Despite lower oil and gas prices, rig utilization was “bouncing off a new high,” near 2,000 rigs, according to Baker Hughes’ weekly rig report.


“But this means that we can’t add to that capacity because financing can’t be raised,” Pritchard says. “The oil and gas business is highly dependent on the ability to raise capital, whether it be debt or equity, but everything is bottled up right now.”


There are debt providers willing to lend to producers, but it’s expensive, he says. “We haven’t had to turn anyone away, but it’s taking longer to get the deals done. Managers are asking themselves if they need to do this deal now or can wait a little bit.”

All bets off
Shale players, in particular, are being affected, with several paring their capital spending plans. With the advent of horizontal drilling in the Marcellus, Haynesville and Barnett shales, Pritchard had expected to see a glut of gas in the market. Now, he says, “all bets are off.”


While Gulf Coast operators are still licking their wounds from hurricanes Gustav and Ike, and half of Gulf of Mexico production was shut in at press time, some producers may not be able to raise financing to continue programs.


“It’s a sign of the times,” says Pritchard. “All the financing that people were exponentially figuring into their models isn’t going to be around. And it affects rig capacity everywhere (including offshore).”


Pritchard and his team have evaluated economics for new-build deepwater semisubmersibles and drillships that are expected to come to market between 2009 and 2012. Most are spec builds, and as much as 40% of these rigs may not be built, or may be delayed, directly as a result of the illiquidity of debt-capital markets, he says.


The equity market is also problematic. Producers are reluctant to issue equity to fund operations and drilling programs, because they perceive their stock price as undervalued, falling precipitously with oil and gas prices and pulled down with the overall equity market.


For the week ending October 5, no U.S. E&P or oilfield-service stock posted an improved price, among the hundreds reviewed weekly by Tristone Capital for the newsletter OilandGasInvestor.com Today. All were down—for the first time in the two years that Tristone has tracked these stock prices for the newsletter.


“Chesapeake Energy Corp., a perennial issuer of equity, saw its stock’s price drop to a 52-week low,” Pritchard notes. “National Oilwell Varco Inc. was down more than 20%, yet it has more backlog now than it has ever had in its history.


“Also, Petrohawk Energy Corp. was at $17. But Petrohawk was at $17 before the Haynes­ville shale play (was announced). Effectively, the Haynesville has just been erased from everyone involved there, like it was never even discovered.”


Houston-based Petrohawk, which in August announced plans to offer 25 million shares using Lehman Brothers and Merrill Lynch as joint book-running managers, now plans to reduce its 2009 capital budget by a third. Still, Petrohawk was able to complete a redetermination of its credit facility, which was increased to $1.1 billion from $800 million, on September 10. The facility is currently undrawn—conserving dry powder, no doubt. The company reports that it “has no current plans or need to access the equity capital markets.”

A&D deals
In the acquisitions market, deals are not being closed, are being revised or are not going onto the market. “I am a little shocked about the Antero Resources deal. Antero is one of the better-funded E&Ps by private-equity groups,” says Pritchard. On September 30, Denver-based, privately held Antero Resources Corp. announced a renegotiation of its deal with Richmond, Virginia-based Dominion Exploration & Production.


The deal, announced in June, involved Antero buying 205,000 acres prospective for Marcellus shale in Appalachia for $522 million. Dominion scaled back the sale, however, “due to Antero’s difficulty in obtaining follow-on financing in the current market turmoil.” Per the new deal, Antero will gain drilling rights to 114,259 acres in the Marcellus play for about $347 million, some $3,037 an acre, which represents a higher value per acre than the prior agreement.


Formed in 2007, start-up-and-exit veteran Paul Rady’s Antero had a $1-billion private-equity line of commitment from Warburg Pincus, Yorktown Partners and Lehman Brothers Merchant Banking.


Meanwhile, on October 1, Denver-based Forest Oil Corp. managed to close its acquisition of producing assets in the Buffalo Wallow and East Texas/North Louisiana areas from George Solich’s Denver-based Cordillera Texas LP, but deal terms had to be revised.
Cordillera accepted a smaller amount of cash and a larger amount of Forest shares in the $892-million deal. Meanwhile, Forest has put some assets on the market to raise cash.


“The disruption in the credit markets is adversely affecting the timing of our divestiture program as counterparties are challenged to receive adequate financing,” says David Keyte, Forest chief financial officer.


Stephen Richardson, an analyst with Morgan Stanley & Co. Inc., underlines Keyte’s concern. “The industry continues to scale back development programs, monetize assets where available and shift exposure out of short-term debt financing,” he says.


“Examples…include the issuance of medium-term notes by Apache Corp. and 2009 capex cuts from resource names such as Sand­Ridge Energy Inc. and Petrohawk. Elsewhere, the equities of Canadian oil-sands names were hit by concerns over the cost and availability of future development capital.”


Rodney Waller, senior vice president and chief governance officer for Range Resources Corp., Fort Worth, says, “The E&P side of the energy business had been drilling in excess of cash flow for the last two and a half years. We are going to have to cut back.


“You can’t perpetuate this drilling activity with the credit markets and the fragility of the debt markets. Therefore, that ‘wall of gas’ (from the shale plays) that everybody wants to talk about, can’t get here if nobody wants to drill.


“In fact, my board made it perfectly clear. They said we can do anything we want to, but anything over cash flow we want for capex, we better sell something, because we aren’t going to the equity markets and we’re not going to the debt markets.”


While reservoir and geological risks are common among E&P companies, Waller says there is now a capital-partner risk. “I am concerned that I might have a bank that is going to go away and can’t fund its commitment under these conditions from the crunch,” he says. “JPMorgan, today, on our rollover revolver draws, will no longer give me funds from a bank unless that bank has actually sent that money to them.”


Some banks are hoarding cash, and the cost of loans is going up.


Mark Fuqua, senior vice president, energy finance, for Dallas-based Comerica Bank, says, “In general, banks are looking for more pricing. A little more is asked for on the service side than on the E&P, as E&P is probably the last to be affected, and the least affected. But that’s changing, and it is taking higher pricing now to get banks to commit to E&P as well as service deals.”


Larger deals are more difficult to put together than in the past. “In general, many banks have been hit by losses and lower earnings. As a result, their capital ratios may be under pressure. They are being more selective about what deals they want to do.”


Nonetheless, Comerica has “lots of money available” for both existing and new clients. “We define relationships as being not just a credit relationship but an opportunity where we can have a deeper and broader relationship and provide other banking products to the client.”

Hedging-based deals
Commodity-hedging scenarios are also changing, mostly due to increased commodity-price volatility, Fuqua says. There is perceived additional risk for hedging counterparties, causing a harder look at the loan price banks ask for in derivatives-based deals. Financial institutions and other counterparties are looking for more compensation for that risk, he says.


While investment banks recover from the turmoil, and those that must, integrate newly acquired firms into their operations, there is another haven for hedges, and a number of producers are turning to it.


“In September, we started to see a lot of hedging activity as producers started actively calling BP to inquire about establishing legal contracts for financial commodity transactions,” says Frank Verducci, director of financial products at BP Energy Co. BP handles financial derivatives for the entire spectrum of E&P, midstream, power, private-equity firms and other financial-institution counterparties at its headquarters in Houston and offices in Calgary and Chicago.


“These producers had commodity trades with counterparties that­­­ they felt were no longer creditworthy. The past few weeks we have seen numerous financial institutions either being downgraded by the credit-rating agencies or entering into mergers with other financial institutions,” he says.


BP Energy is the leading energy merchant in North America, with its AA credit rating and physical energy platform that enable it to market 29 billion cubic feet of gas per day.


“Many producers have a high comfort level with us because they have purchased and sold physical crude oil, natural gas and natural gas liquids with BP in the past. At this time, BP is benefiting from this new flight to quality with increased commodity derivative transactions,” he says. Producers turning to BP for hedging transactions include publicly traded E&Ps with market caps ranging from $1 billion to $4 billion—some that had not done financial energy-derivative transactions with BP before. “They realize we have physical energy assets and are not involved in the types of financial trades that are affecting the other institutions.”


Verducci notes that there are a number of counterparties that either no longer exist or have merged since the meltdown. Bear Stearns had an energy-trading business, Lehman Brothers had a physical and financial energy-trading business, UBS is exiting the energy commodities business, and the mergers of Bank of America and Merrill Lynch and BNP Paribas and Fortis took further trading liquidity out of the market.


Martin Fritz, president of Equitable Midstream and vice president of Equitable Resources Inc., does see a silver lining in this black cloud, however. “Right now, people are not being efficient with capital. You see a lot of players out there just running like crazy.”


For instance, for new-build pipelines needed in the hot shale plays during the past two years, contractors “have the E&Ps over a barrel” when it comes to pricing pipeline construction, with a “take it or leave it” attitude.


“Now, the pendulum is swinging the other way. I think, for those operators with good cash flow, if we continue building pipe during the downturn, we will get better cost, efficiency and quality.”

Global oil prices
Meanwhile, Libor (the London Interbank Offered Rate) peaked at press time at 6.8%, causing financing costs to soar, and putting upward pressure on loan prices across Europe and the U.S.


“The outlook for global equity, interest-rate and exchange-rate markets has become increasingly uncertain,” says Deutsche Bank’s Washington-based chief energy economist Adam Sieminski.


“We believe commodities will be unable to escape the contagion with the complex prone to overshooting risks both to the upside and downside,” he says. “Our first concern is the precarious nature of global equity markets. If the U.S. continues to lurch from one crisis to another, it seems very probable that the S&P 500 has further to decline.”


With the relative values of the U.S. dollar and the EU’s euro in flux, Sieminski says there may be further upside-price risk to crude oil, which has become “mesmerized by the ebb and flow of the euro-dollar exchange rate.”


“However, from a commodity perspective, our most pressing concern is to what extent the U.S. virus spreads globally—specifically to China. For many commodities, such as aluminum and crude oil, China represents a significant share of global consumption growth. We expect demand-destruction fears into early 2009 will bear down on many commodity prices,” he says.