17 May 2016

Shifting Restructuring Challenges in Volatile Oil & Gas Industries

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Driven by oversupply and drops in the price of oil and natural gas, the oil and gas industries are facing a spike in restructurings and bankruptcies over the course of the coming year and into 2017. With restructuring and bankruptcy announcements ramping up, including news from big players like Energy XXI and SandRidge Energy, 2016 is already shaping up to outstrip 2015.

Deepening Problems, Broadening Scope

Many are comparing the current period to the downturn of 1986-1987. According to oilprice.com, the “CBOE Crude Oil Volatility Index, a fund that tracks the volatility of crude oil, has spiked to a level not seen since the global financial meltdown in March 2009.”

The Wall Street Newscast reported that Moody’s Liquidity Stress Index for oil and gas in February reached 24.4%, “bringing it within a squeak of the record of 24.5% set in March 2009.” Although optimism regarding an oil and gas price recovery persists in some quarters, for the most part, the view is pessimistic for the remainder of 2016 and into 2017.

John Castellano, Managing Director, Alix Partners

John Castellano, Managing Director, Alix Partners

We sought an opinion on the price rally from John Castellano, Managing Director at Alix Partners, an advisory firm, and Bradley Hunter, Director. Each has over 15 years of restructuring experience. They work currently at Energy & Exploration Partners, where Castellano is serving as Interim CFO. Neither Castellano nor Hunter see the oil price rally as a game changer.

John Castellano comments, “The recent oil price rally should not have a short-term timing impact on certain restructuring situations as nothing has changed the overall outlook for the oil and gas industry in 2016 and 2017. Oversupply continues to keep oil prices low and provide encouragement for producers to restrict capital spending on development and this is unlikely to change as long as Saudi Arabia and Russia refuse to cut production, especially given that Iran is set to reenter world oil markets.”

Many analysts are in agreement that bankruptcies are inevitable for a growing number of distressed companies. In a report released in February, auditing and consulting firm Deloitte claimed that as many as one-third of oil producers, or 175 companies with over $150 billion in debt, are at high risk of bankruptcy.

BHunter

Bradley Hunter, Director, Alix Partners

Hunter remarks, “Overleveraged companies which found easy access to funds during the good years are going to continue to face the same pressure they have faced for the past 12-18 months and will need to instill the necessary capital discipline and develop innovative ways of managing their cost structures in order to avoid becoming a tombstone.”

As the industry picture worsens, the problems deepen, as a “domino effect” takes over. Already, oil producers’ problems are affecting midstream participants. The recent judge’s decision allowing Sabine Oil & Gas Corp. out of its pipeline contracts is a prime example of the unexpected ways problems can spread.

John Castellano says of the decision, “The recent Sabine situation may have a material impact on the midstream sector as this sector of the oil and gas business was relatively untouched over the course of 2015. Upstream companies could use the reference of the Sabine decision, while not completely binding, to attempt to reject and/or renegotiate midstream contracts.”

“Many midstream agreements contain minimum volume commitments which have become too burdensome for E&P companies to maintain in a declining production environment.” Castellano concludes, “The industry may very well see a shakeout in the midstream sector as a result of this momentous decision.”

Shifting Landscape of Challenges

According to Alix Partners’ Global Oil and Gas Industry Outlook, “projected revenues of 134 North American–based E&P companies show there could be a gap of $102 billion against their operating and capital expenditures in 2016, signaling a need for major financial and operational adjustments.”

Restructuring professionals must deal with many challenges in making those adjustments, from finding a way to maximize returns on funds during the pre-confirmation phase to managing the conflicting interests that arise from oil and gas companies’ complex capital structures. In a fast-moving landscape, negotiating asset sales is one of the more difficult tasks faced.

Bradley Hunter comments, “Managing the sale of a distressed asset in a distressed industry and achieving a targeted sales price can be a challenging task. Buyers are scarce and sellers can be found around every corner as many industry players look to shed non-core assets to trim budgets and raise cash.”

Hunter offers some words of advice, “While there are some levers the seller can pull to help to increase the price (e.g. selling free and clear of any liens and encumbrances via a 363 sale) the seller is operating in a buyer’s market and may not be able to reach the level of recovery that stakeholders aspire for. Casting a wide net in approaching interested parties and being flexible regarding customized terms and conditions can help.”

The spring redetermination period, when banks re-examine oil and gas companies’ borrowing base, is currently underway. As Forbes has reported, companies like Citigroup, Bank of America, J.P. Morgan Chase and Morgan Stanley each have potential loss exposure through oil and gas loans in the double-digit billions. With prices remaining lower, a reduction in borrowing bases is expected.

Bradley Hunter spoke to us about oil and gas companies’ ability to secure capital or relief from existing lenders. “On the lender side we are seeing that many sources of funding have significantly cut, or altogether eliminated, the amount of funding set aside for oil and gas investments,” states Hunter. “While funding sources do remain they tend to be somewhat mercurial and require a higher commitment on the part of the borrower.”

For restructuring professionals and Chapter 11 trustees, the upsurge in oil and gas companies in need of their services ends several years of reduced activity. With widening casualties among creditors and in hard-hit regions like Texas and Oklahoma, the wave of increased activity has yet to reach its height.

About BMS

BMS offers end-to-end case administration software and UST-approved high-yield, flexible depository services specifically designed to meet the needs of Restructuring Fiduciaries, Bankruptcy Trustees, and Receivers.

About Alix Partners

AlixPartners is a leading global business advisory firm of results-oriented professionals who specialize in creating value and restoring performance. The Turnaround & Restructuring practice is comprised of the most respected turnaround professionals in the industry. AlixPartners is widely recognized for its long and successful track record in helping companies resolve urgent situations and implement rapid change. Learn More: AlixPartners.com

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