Time of the Season-Fall Borrowing Base Redeterminations for E&P Companies Subdued So Far

Although many industry observers predicted draconian cuts to the credit lines of North American E&Ps during the fall borrowing base redeterminations by their lenders, the average reduction for 17 companies disclosing the results to date is just 4%. Today we describe how these results may indicate that significantly lower industry costs and less dramatic reductions in long-term commodity price forecasts could be partially offsetting the negative factors used to determine borrowing capacity under secured and unsecured credit lines.

Secured loans provided by banks to exploration and production (E&P) companies use the value of the oil and gas reserves that an E&P owns as security or collateral. Banks typically determine “base” borrowing limits for these loans that are linked to the value of the collateral hydrocarbon reserves. These loans are important to E&P companies, particularly the smaller ones, because they allow them to borrow money more cheaply (i.e. at lower interest rates) and in larger amounts than they might be able to otherwise. Banks revisit or “redetermine” the terms of the loans twice a year, once in the spring and once in the fall. These are typically not very newsworthy events except when oil and gas prices have declined sharply since the value of the collateral declines as well.  There has been a lot of trepidation over the fall redetermination this year (2015) since, by all accounts, the spring redeterminations resulted in minimal changes to E&P borrowing bases despite the collapse in oil prices that started over a year ago.   Reductions in borrowing bases strap E&P companies for capital needed to reinvest in developing oil and gas reserves. Less capital available results in fewer wells drilled, lower cash flow and presumably lower production. 

So secured borrowing bases of E&P companies are largely determined by the value of their oil and gas reserves and any additional unsecured borrowing lines (i.e. with no collateral) are backed by the overall credit quality of the company. Generally speaking larger companies with deeper pockets have higher credit ratings while these are lower for small independent E&P companies. Since oil and gas reserves are worth much less today than they were under a $90+ WTI oil price environment, the credit quality of E&P companies has been diminished as a result. However, while access to capital has become more difficult, per unit drilling and completion (D&C) costs have fallen about 25% since year end 2014, based on analysis RBN presented at our recent School of Energy in Houston (see Table 1). This is one of the reasons why capital spending has been reduced so sharply, which was highlighted in our analysis: Changes to Upstream Capital Spending and Production Estimates in 2Q/15. Lower costs mean that E&P companies can get more D&C bang for their bucks.