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Slump in Crude Oil Price Creates
Growing Risk for Creditors
By: Brett S. Theisen
In the last 18 months, the price of a barrel of crude oil has fallen from nearly $110 to $26 on January 20, 2016. The most recent slide – to a 13-year low – exacerbates an already dire situation for energy companies and their lenders. To date, the upstream exploration and production ("E&P") sector has taken the hardest hit. In 2015, 42 E&P companies commenced bankruptcy cases in the U.S. and Canada.
From a creditor's perspective, the greatest damage so far has been to regional lenders that issued loans directly to the E&P sector. For lenders in North Dakota, Alberta, Texas, and other shale-dependent areas, energy loans can account for anywhere from 20-40% of their entire portfolio. In addition, for many of those lenders, the risk goes beyond direct E&P lending because during the boom times they were funding oil workers' mortgages and credit cards, as well as capital loans and credit facilities to the local businesses and governments that live off the oil industry. Many of these secondary loans are also increasingly susceptible to default. The broader concern, however, is that if regional lenders become insolvent, a contagion could spread to the overall financial sector – including the big banks – and the economy as a whole, creating a crisis situation akin to that seen in Texas during the 1980s.
E&P companies have experienced deep cuts to their borrowing bases over the past year, which are ordinarily tied to the value of proven oil reserves in the ground. Because crude prices are expected to remain stubbornly low, or fall further still, borrowers and lenders alike should brace for even steeper borrowing base decreases. In the past few weeks, multiple industry analysts released $20/barrel forecasts, with one predicting the price could go to $10. Indeed, many lenders have already been increasing their loss reserves in anticipation of defaults, in some cases by billions of dollars. The longer the price slump continues, the less likely it will be for E&P borrowers to restructure their debt obligations, or sell off non-core assets. At some point, chapter 11 will become the only viable option for many firms.
A tidal wave of bankruptcy filings could spell disaster even for secured lenders. Even though most loans are asset-backed, in many cases the insolvency value of the collateral is dubious, particularly for banks that have been "lending on iron," i.e. allowing E&P firms to use drilling equipment as collateral. In an environment where rig counts have fallen by the thousands and hundreds of thousands of jobs have been slashed, liens on drilling equipment will provide little comfort. In short, "secured" may not mean what it usually means for many lenders.
As noted above, 42 E&P bankruptcy cases were commenced in the U.S. and Canada during 2015. Nine of those cases – including eight of the ten largest by total debt – are pending in Delaware or the Southern District of New York.1 With most experts predicting sustained low prices through 2016 and into 2017, Gibbons counsels diligence and careful monitoring for lenders – even those with little direct exposure to the energy sector – and urges the adoption of strategies to deal with a looming crisis that could infect the broader economy. For unsecured lenders and creditor committees in E&P cases, lien challenges to the secured debt may offer a path to greater recovery. Finally, junior creditors and equity holders should investigate potential fraud and equitable subordination claims with respect to inflated or misrepresented borrowing base certifications.
1 See In re Quicksilver Resources, 15-10585 (D. Del.); In re Milagro Oil & Gas, Inc., 15-11520 (D. Del.); In re Sabine Oil & Gas, 15-11835 (S.D.N.Y.); In re Samson Resources Corp., 15-11934 (D. Del.); In re Parallel Energy L.P., 15-12263 (D. Del.); In re Cubic Energy, Inc., 15-12500 (D. Del.); In re Magnum Hunter Resources Corp., 15-12533 (D. Del.); In re New Gulf Resources, LLC, 15-12566 (D. Del.); In re Swift Energy Company, 15-12670 (D. Del.).
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