Christopher Abbate, managing director, Riverstone Holdings LLC recently discussed private credit funds and alternative lending sources. Plus, Abbate talks implementing international strategies.

Hart Energy: Nearly half of all E&Ps with bank debt coming due are finding their grade is substandard. Why is that?

Abbate: In terms of the percentage, I am not sure that it is exactly half but a fair number of E&P companies had their bank lines downgraded to a substandard rating under the OCC guidelines. The reason for that in this go around was that they changed the guidance to include total leverage ratio as part of the criteria that they look at.

In the old days, substandard for oil and gas was really more of an advanced rate issue, how much was advanced against proven reserves and what the payout of the facility was under various commodity prices. This time around they had their old standards but also added a total leverage standard, which when you have a lot of high yield bonds behind your revolver in the capital structure, can lead to some issues.

There were a fair number of downgrades in the 2015-2016 time frame. Today though, a lot of that has been alleviated. First, by the reorganizations that happened and the bankruptcies that took away a lot of that unsecured debt that was there. Also, performance is up with commodity prices being higher. I don’t think there are as many substandard companies out there today. Now, as these revolvers come to mature, the ability to replace them at the same size they were at previously will be challenging I think. Capital from banks is much harder to come by as evidence that standards that make a conforming loan have changed and been tightened. It is going to be a challenge to get all that bank debt refinanced in the bank market. I think that is where private credit can actually play a role.

Hart Energy: Is private debt the answer to getting capital to grow?

Abbate: The traditional sources of credit for upstream companies have been the bank market, the revolving credit facilities RBLs and the high yield market. We just talked a little about the challenges in the bank market and how the standards there have tightened, which has restricted the amount of capital available.

In the high yield market, they are still willing to price risk what the banks can’t price, but they won’t price the liquidity. What makes a liquid loan or a bond is much bigger today than it was 10 years ago. For example, the average high yield deal in the market in 2002 I think was around $230 million. Today that’s over $700 million. So, it’s a massive increase in size to access that market. So, what fills the gap? That’s where private credit can come in, both for risks that the banks can’t or won’t price and deals that would normally be priced by the high yield market but are just too small. That is where we are seeing a lot of opportunity right now.

Hart Energy: Do you see alternative lending sources filling in the gap for capital-hungry energy companies?

Abbate: Private capital is a massive pull. Think of it as institutional investors like endowments, pensions or family offices that basically want to tie their money up for a long period of time and earn excess rates of return for doing that. Of course, there is the traditional private equity that everyone is familiar with. There are also alternative forms like DrillCo structures which are basically sort of private investors serving as a farm-out participant in a field. There are companies that just buy royalties and there are companies that buy nonoperated working interests. These are all just alternative forms of capital to help things move along. There are a lot of different flavors out there and a lot of different participants willing to provide that capital.

Hart Energy: Most oil and gas investing is here in the U.S., but several private equity firms are implementing international strategies. What are the advantages to looking at fields outside of the U.S.?

Abbate: Well from a credit perspective, there isn’t much to be honest. We can earn very attractive rates of return in North America and obviously it’s a much safer jurisdiction from a perfection of liens perspective. For private equity, I think there is a great opportunity outside North America particularly on a cost basis because you can get into plays much more inexpensively than you could in some of the core basins in the U.S. There is a lot of risk obviously in terms of proving these things up and there is a lot of jurisdictional issues in terms of access to minerals and access to markets.

There is a lot of complexity to work through, but ultimately producing oil or gas at the cheapest possible imbedded cost is what makes money. I think there are good opportunities overseas.

Hart Energy: In what areas internationally do you see the best opportunities? The Vaca Muerta, for example, has seen a lot of opportunity.

Abbate: My company, Riverstone, has a business down in Argentina that is focused on that play. I don’t know enough about it to give you a lot of detail, butut I think that is the type of play that can be very interesting because geologically it is very similar to things you see in North America like in Canada and the Permian Basin. That’s in terms of the quality of the rock, but the entry level is much lower in terms of what you can acquire acreage for and how you can develop it.

The challenges are there are no exports per say from Argentina. So, it’s mainly for local consumption. That economy uses a certain amount of oil and it’s growing at a certain rate. Whether that has the benefit of some price appreciation as well is unknown. Ultimately, I think that is the type of thing you can look to that would be interesting.

Hart Energy: Rather than selling to public E&Ps, private equity firms are increasingly exiting through a sale to other larger PE sponsors that need investments of greater size to meaningfully impact their portfolios. Do you see this trend continuing? What is the future of IPOs?

Abbate: The shift in mindset for investors around capital discipline has sort of lengthened the runway for many private businesses that maybe started with a hope to put together a team in a drill ready package and then maybe flip it to someone with more resources to fully develop it out. I think both the public and private markets are demanding that those businesses be cash-generative before there is a massive premium put on them from an M&A perspective. We see this in our business in private credit.

We can be a helpful solution in that regard because a lot of times you will be ready to drill and have a lot of asset value, but not necessarily have the cash flow or the proven reserves to get bank financing to help bridge that gap. That is where firms like mine can come in and help do that, to extend that runway and help get that growth and production level up to sort of a breakeven point, where they are an attractive M&A candidate from either a private or public company.

Some of the other alternative capital sources can be helpful as well [like] DrillCos selling off of working interests and things like that. But, ultimately those are probably more dilutive to the original equity than say a credit line would be. There are a lot of alternatives and I think you are absolutely right. That is a growing trend that people are going to have to adapt to over the next six to 12 months.