By Paul Wiseman
In the early shale boom days of 2010 and off-and-on through about 2018, getting financing was relatively easy. Private equity (PE) funds and banks alike saw the drilling and production boom as an opportunity to grow their investments. Funds looked to buy into both operators and oilfield service companies, bankroll a huge growth surge, then flip the company to another fund or an actual oilfield company at a huge profit. Sort of like Chip and Joanna had taken “Fixer Upper” to the oil patch.
Then it became a real reality show. Reality hit all parties, and by 2020, even before the pandemic, lenders were backing off and investors were beginning to demand actual returns. The sudden crash of 2020 made investors even more nervous.
In 2023, those nerves along with environmental agendas aimed at ending the dominance of fossil fuels have shrunk the field further, according to all three experts included in this report. Larger banks are buying smaller ones in the oil patch, and many are either divesting energy notes altogether or simply maintaining those they already have, without seeking new opportunities.
Grant Swartzwelder
Said Grant Swartzwelder, Principal of Petro Growth Advisors, “You start talking about the shrinking availability of banks, with the shrinking ability to do loans… a lot of them are tightening up their credit, requiring more collateral.” The bottom line is that lenders are now more risk-averse than ever.
Those banking concerns mean borrowers will get less money. “That either means you have to have equity, you’ve got to do personal equity, or you’ve got to get outside equity, and there are challenges with that as well,” Swartzwelder said.
And it’s worse in regards to PE groups, he noted. Many oil and gas PE firms, like Natural Gas Partners, EnCap, and others, are indeed raising money in today’s market. But, “They’re not raising nearly the amount of money that they raised five years ago,” Swartzwelder said, observing that their ability to raise money at all these days “is significant.”
He continued, “With the whole ESG [environmental, societal, and governance] overhang, you could argue that two or three years ago they couldn’t have raised any money, and very few did.” That was during the depths of the pandemic, when oil and gas prices alone were a deterrent to raising investment cash.
In 2023 they now can raise some money, he said, but only about half or a third of what was previously possible. Even there, half of that half is often geared toward energy transition—wind, solar, battery storage, and others, leaving much less for traditional exploration and drilling.
Swartzwelder sees capital availability only shrinking in the near future. Drilling and exploration will thereby be limited, “And it’s going to be a challenge over the near term for independents to grow.”
Before the pandemic, majors would buy either assets from a smaller company, or buy the whole company. Then after a period of evaluating what they had, the buyer would spin off “the bottom 20 percent” of those assets, too small to be economical for a large company, to another small independent. The smaller company would then continue to squeeze more oil and gas out. But fewer buyers are spinning off those marginal wells, and the rising costs of environmental regulations are also a hindrance, he said.
“Now you’ve got regulations requiring [methane] vapor to be managed—either destroyed [flaring] or captured. That adds cost to that well,” he said. And a marginal well, by definition, may not bring in sufficient cash flow to support extra overhead.
Frost Bank’s Adjustments
Regarding the reduction of risk, Frost Bank’s Executive Vice President, Jack Herndon, said more institutions are requiring producers to hedge production in order to get a loan. “Five years ago, you only did that on certain loans. We do it on most every loan now.” While oil prices have somewhat stabilized in the last two years or so, the price collapses of 2018 and the Covid shutdowns sent shock waves through capital markets, leading to hedging, smaller loans, and other risk-reduction measures.
Jack Herndon
Herndon quoted figures showing that the WTI average oil price in 2021 was $67.94, rising to $94.29 in 2022. Through June 30, 2023, “we’re at $75.01” per barrel.
Even with that relative stability, credit terms remain tight. “Banks have really tried to hold the line, to avoid that creep” [of slowly relaxing standards down to an unacceptable level], he said. He added that borrowers are of the same conservative mindset, “Because they don’t want to go through that brand damage again either.”
For their own risk management, Frost has built new metrics into their lending process. “We’ve incorporated a blow-down analysis into our credit underwriting standards, so that we can look at a company and say, ‘Are we sure that in a little bit of a stressed commodity price environment, they can pay the loan back?’”
Possibly lurking in the DNA of bankers today who were too young to remember it, is the 1983 FDIC shutdown of First National Bank Midland due to delinquent energy loans. While that was a worst-case scenario unlikely to repeat, the early 2023 failure of Silicon Valley Bank and some others have shown that single-industry institutions still need to be on the alert—and energy lenders are all very careful these days.
Hurry Up and Divest
Echoing Swartzwelder’s observation that current M&A buyers are waiting to spin off low-producing acquisitions, Herndon said, “We’re impatiently waiting on the next cycle. Because, inevitably, some of those big players that have been on a buying spree are going to want to divest some of the non-core assets that they purchased as part of a larger package. When that happens, I think it’s going to create some opportunities for the smaller, more-efficient operators out there who are our target market.”
Sometimes the selloff of low-end assets is triggered by a price drop, causing budget makers to seek ways to improve margins, he said.
Interest Rate Headwinds
“I think inflation, rising interest rates, and the current environment of regulatory uncertainty have had a far more profound impact than any geopolitical events,” he said. Inflation, especially in the oil patch, along with the fact that “interest rates have effectively doubled,” means that payments are higher even for loans of similar amount as those of a few years ago, and every dollar that is borrowed accomplishes less work.
American Momentum Bank
Jarod Thomas
Jarod Thomas, West Texas President at American Momentum Bank, sees ever-tightening government and regulatory issues as major dampers on energy lending in the Permian Basin. While “Energy independence has never been more important, in my opinion, we’re [through government policy] choosing to go in the opposite direction.”
New regulations sometimes take a while “for the ball to roll downhill” to reach smaller banks, he said. Many times they come into play at the time of a bank’s regularly schedule examination by the FDIC or the Texas Department of Banking, depending on who a bank is regulated by (such as a state or federal registration).
For a while the energy industry looked good to lenders, Thomas noted, because players, especially majors and large independents, were diversifying into “commercial development, agriculture,… hotels [and] hospitality,” he said. So that diversity was seen as spreading risk across several sectors.
However, the current landscape of increasing regulation of banks and the oil and gas industry is a significant factor driving many lenders out of the space, Thomas believes. “Some of the normal players have have started to say, ‘We’re going to maintain our existing customers and take care of the needs they have, not looking to take on any new clients.’”
As stated above, price hedging is becoming foundational in getting loans for Reserve Based Lending (RBL), in which the loan is secured by a company’s reserves. While banks previously looked for about 50-70 percent of a portfolio to be hedged, now, Thomas said he’s heard that “That’s increased to 790-80-90 percent, so hedges have become a bigger factor.”
And, as Herndon also noted, Thomas sees many producers being proactive, coming to the loan desk with hedges already in place.
For service companies, banks that previously required down payments of 15-20 percent are now asking 30-35 percent.
AMB, along with others, also offers service companies a factoring option. In factoring, the provider lends the service company a percentage of the latter’s accounts receivable, then collects the money from the service company’s client, usually an E&P. This system is in place because many producers routinely pay invoices 60 to 90 days after receiving them. Factoring allows the service company to avoid the delay, while paying the factoring company a percentage of what is collected.
Overall, as long as oil prices stay well above break-even levels—and look like they’re going to stay there—oil and gas companies should be able to find lenders. The terms, conditions, and interest rates may not be what they were used to, but with some adaptation, at least some funding should still be available.