New asset-backed bonds divert shale sector away from bank lending

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(Bloomberg) — As big banks forego lending to oil and gas drillers, some U.S. energy companies are relying on a new type of bond to get the financing they need.

Bonds are backed by companies’ oil and gas reserves, which means that producers essentially pledge revenues from their wells in exchange for upfront cash. Debt known as “proven in development in production” securitizations can allow shale drillers to pay less to borrow, in exchange for giving up some of their possible gains if energy prices rise.


This year, companies have sold, or are selling, $4 billion of PDP securitizations. That’s up from the total of just $1.4 billion in the previous three years, according to data from Fitch Ratings. The first such bond was sold in 2019.

Energy companies are heavily reducing their borrowing now as they are flooded with cash. New loans to oil and gas companies fell more than 30% from 2018 to 2021 and are on track to fall again this year, according to data compiled by Bloomberg. Banks have also come under pressure from regulators and investors to cut lending to an industry notorious for overspending during booms followed by busts.

But many energy companies still need financing. Colorado-based Jonah Energy sold a $750 million PDP securitization this month, backed by the rights to proceeds from about 2,400 oil and gas wells — virtually all the wells it owns. The driller will pay a return of around 8% for its PDP securitization with an average life of three years.

By contrast, British oil and gas driller EnQuest Plc this month sold five-year unsecured bonds at a yield of 12%.

By selling a PDP securitization, Jonah managed to achieve substantial savings, all the more impressive considering that just a few years ago the company could not pay its obligations. In 2020, at the start of the pandemic, the company restructured its balance sheet to reduce its debt, raise equity and sell the majority of the company to certain former noteholders.

Securitizations also offer other advantages, especially when energy prices fall. A common alternative form of financing, known as reserve-based loans, is also collateralized by a company’s wells. With these loans, every six months the banks estimate the value of the oil and gas wells that secure the loan.

If assets have lost value, companies must reduce their borrowings or offer more collateral. And even in good times, when prices rise, drillers may not see their borrowing bases increase, which means companies may not be allowed to borrow more. According to a survey of borrowers and lenders in the reserve-based loan market by Haynes and Boone, a law firm, high oil and gas prices have not led to an increase in the loan base. borrowed recently.

With PDP securitizations, collateral is not revalued.

“It’s a more permanent source of capital,” said Greg Kabance, chief executive of Fitch.

Jonah is using the proceeds from his securitization agreement to refinance his existing reserve-based loan, according to a statement from Tom Hart, Jonah’s president and CEO. The agreement “positions us with a strong balance sheet to pursue the significant drilling opportunities we have on our acreage and the strategic opportunities that may come our way,” he said.

But there are also downsides to these agreements. To protect investors in PDP securitizations, companies that sell these bonds typically enter into derivative transactions that effectively provide them with stable income from the assets over the life of the bonds and reduce their potential gains from increases in energy prices. . Banks that sell these derivatives bear the risk of falling oil and gas prices and reap the benefits of rising prices. Wall Street firms can hedge their exposure using options and other instruments.

These derivatives are one of the reasons why large integrated oil and gas companies like Exxon Mobil Corp. have avoided selling PDP securities: they do not want to give up their potential gains. So far, the space has been mostly dominated by smaller private companies, some of which have gone through multiple securitizations. They include Wyoming-based gas producer PureWest Energy and Denver-based Raisa Energy, which owns and leases oil assets in North America. Diversified Energy, owner of a sprawling well empire in Appalachia, has completed six.

In addition to pressure from regulators, banks have come under pressure from investors to reduce their exposure to companies considered risky from an environmental, social or governance perspective.

“Fewer and fewer banks these days are willing to lend to the upstream oil and gas industry, in part because of ESG and other concerns,” said Michael O’Leary, partner at law firm Hunton Andrews Kurth, who has written about PDP securitizations.

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