April 26, 2012
For U.S. natural gas producers, it's the credit crisis all over again. As prices of the fuel tumble to their lowest in ten years, big lenders are set to slash credit lines to the most exposed producers by as much as a quarter, forcing firms to conserve cash by cutting back on drilling plans or to sell assets. As part of a twice-yearly process of reassessing more than $60 billion dollars in loans to the energy sector, bankers are already telling some mid-sized outfits like Penn Virginia Corp and Carrizo Oil and Gas to expect some of the biggest cuts since the financial crisis in 2008, according to interviews with more than a dozen lenders and producers.
"It could get nasty out there," said one loan manager involved in the bi-annual "redeterminations" process during which banks consider how much capital they will extend to energy companies based on forward commodity prices, a company's production outlook and its hedging program.
The current round of lending curbs, due to be completed within the next few weeks, may not cut so deep at companies that can pivot away from gas production and drill for more lucrative oil, which is trading at a record high relative to gas. And others have tapped less than half their credit lines, leaving some cushion to absorb a reduction without distress.
There are also large debt-laden companies like Chesapeake Energy that tend to rely more on longer term debt by borrowing through the bond market, giving them some protection from the bank credit process. But redeterminations can provide, or choke off, the life blood of smaller companies. If the surge in shale gas production continues to depress prices six months from now, an even more painful round of curbs could follow for companies that produce mainly natural gas or whose production is largely unhedged.
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"You could see some companies that have their liquidity stressed and if these price conditions continue you could see it in the fall as well," said Marc Cuendo, an executive vice president at Wells Fargo who is involved in such loan decisions.
U.S. natural gas prices, which this month traded below $2 per million British thermal units for the first time since 2002, have halved since the last redeterminations took place in November. A mild winter and record production swelled inventory levels and prices do not look ready to recover much soon. Gas producers have unlocked decades of supply from U.S. shale formations, more than they know what to do with. Yet, it became a tainted bounty for producers as demand failed to keep up and prices sank.
"This could be the worst set of redeterminations since 2008, especially if oil prices fall, because they have been providing some support," said Kevin Smith, energy analyst at Raymond James in Houston, referring to the financial crisis in the second half of that year, which caused bank loans to dry up.
Penn Virginia Corp, which was downgraded to negative by credit ratings agency Moody's last month, says it expects a nearly 20 percent reduction in its borrowing base, which is currently at $380 million, when it is announced this week, said Penn Virginia's Chief Financial Officer Steve Hartman.
JP Morgan, the company's lead lender, and other banks are set to vote on cutting the base to $300 million on April 27.
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Though Hartman does not expect this to immediately affect the company's liquidity, since Penn Virginia's previous borrowing commitment – the maximum amount it was authorized to borrow – was already $300 million, it raises concerns about longer term cash flow for smaller companies.
"I think any producer with a significant amount of natural gas is going to be affected by gas prices," Hartman said. Penn Virginia's production is 70 percent natural gas, he said.
Comstock Resources, a small producer with assets in Louisiana and Texas, had expected its base to increase by $100 million to $800 million in the first such reassessment since an oil shale acquisition in December. But low gas prices kept it at $700 million, said chief financial officer Roland Burns. The reduction in the lending base may not cause immediate distress because most companies do not use the entire loan. A review by the resource-focused boutique investment outfit Global Hunter Securities showed that only 8 of about 60 firms it covers had drawn down more than half their credit lines. It said it expected banks to be "accommodative" this time around.
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"We don't imagine the banks will be too eager to take possession of gas assets in this market," analyst John Malone wrote in the April 17 report. "We will however see liquidity tightening for the gassier names, another downside to an increasingly tough market."
Lower lending levels could cut into future investment plans, and prompt even more companies to sell off properties to fund operations, analysts say. Carrizo Oil and Gas, which recently sold gas assets in the Barnett Shale in Texas to Atlas Resources, is bracing for a $40 million reduction in its borrowing base to $300 million, according to the company's vice president of investor relations, Richard Hunter. The final figure will be decided at the beginning of May, he said.
While much of the reduction was because the sale to Atlas had reduced its asset base, low prices will play a huge part in how banks lend to energy companies. "The worse case scenario is that they reduce the size of your borrowing base to below what you have borrowed, so you actually owe money," Hunter said. "That can happen, and that is when companies disappear." Carrizo has drawn on only about 14 percent of its borrowing base, according to Global Hunter Securities.
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Low natural gas prices have crimped profits for producers this year as drilling new pure gas wells became largely uneconomic. As companies feel a squeeze in liquidity, which could occur over the next year if gas prices remain low, they will look for ways to either preserve cash or raise equity.
The result: a potential bargain sale of cheap assets and possible declines in production. Already companies are selling interests in pure natural gas plays and moving rigs over to oil plays that fetch much higher prices. U.S. oil is currently over $100 a barrel, up 25 percent since last autumn. Carrizo's sale to Atlas, which totaled $190 million, is indicative of companies selling assets that four years ago were considered too good to lose.
Ultimately, this spring's redetermination process may be only a warm-up for an even more stringent review in the autumn, Raymond James analysts said in a note this week. "We believe we will see a more active acquisitions and divestitures market over the next 12 months with producers shoring up their balance sheets by divesting non-core assets."