This spring Haynes and Boone, LLP polled energy lenders, upstream oil and gas producers, and other energy industry participants to get their predictions about producers’ future borrowing capacity or “borrowing bases”.  Producers and lenders meet twice a year to assess borrowing bases — determinations that turn on banks’ projections about the future prices of the producers’ oil and gas reserves. The survey, which the firm has conducted twice a year since spring 2015, offers a unique forward-looking view about the projected financial state of the energy market. 

The responses to the spring 2017 survey can be characterized by two words: cautious optimism.  Respondents expect that 76 percent of oil and gas borrowers will see their borrowing bases increase or remain unchanged.  This is improved from Haynes and Boone’s fall 2016 survey, when respondents expected only 59 percent of producers to see their borrowing bases increase or remain unchanged.  The biggest difference between fall 2016 and spring 2017 is the modest oil price recovery that followed OPEC’s November 30, 2016 decision to cut oil production by about 1.2 million barrels per day.  Although oil and gas industry participants are typically skeptical of OPEC’s ability to ensure members’ compliance with announced production cuts, the production numbers released in the months that followed appear to provide some level of confidence in price stability and improvement.

Respondents have a positive outlook regarding how many oil and gas companies will see their access to reserve-based borrowing base credit stay the same or increase, but they do not expect any increases in these credit lines to be dramatic. Of those respondents expecting borrowing bases to increase, the overwhelming majority expect increases to be just ten percent above fall 2016 borrowing bases.  The same goes for those survey respondents who expect borrowing bases to decrease – almost all expect the decreases to be just 10 percent below fall 2016 borrowing bases (with a handful expecting the decreases to be 20 or 30 percent below fall 2016 levels).

One interesting trend seen in prior Haynes and Boone surveys continued in the spring 2017 survey: respondents who identify themselves as borrowers (oil and gas companies) were more pessimistic than respondents who identify themselves as oil and gas lenders.  For example, lender respondents expect 80 percent of oil and gas companies to see their borrowing bases increase or remain unchanged, while borrower respondents expect 73 percent of oil and gas companies to see their borrowing bases increase or remain unchanged. Of respondents who stated that spring 2017 borrowing bases will increase by 10 percent when compared to fall 2016, the lender respondents outnumbered the borrower respondents by two to one.  One theory for this trend is that lenders are focused on outcomes (stable or higher borrowing bases) that will keep their borrowers from falling into distress, workout or bankruptcy in hopes that their borrowers can ride out the rough patch.

If an oil and gas company’s borrowing base is decreased below the amount outstanding on the credit line, the company has, in addition to normal credit facility remedies, a number of alternative paths it can take to address this deficiency, including negotiating an amendment to its credit facility or extension, selling assets, seeking private equity capital, or declaring bankruptcy.  Consistent with prior surveys, the bulk of respondents predict that a producer with a borrowing base deficiency will either negotiate an amendment to its credit facility or extension (43 percent) or sell assets (37 percent).  In Haynes and Boone’s spring 2016 and fall 2016 surveys, 13 percent of respondents noted that companies would file for bankruptcy protection when faced with a borrowing base deficiency.  This number dropped dramatically in the spring 2017 survey – only 3 percent of respondents see bankruptcy as the path that borrowers will take when facing a deficiency. 

This is perhaps a sign that industry participants believe that most oil and gas companies have increased in asset value since the end of 2016 and thus have more tools to work with (e.g., private equity investments, property sales) when their credit lines become over-extended.  In 2016, when there were significant periods of time where oil was priced in the high $20s and low $30s per barrel, a lot of companies’ oil and gas assets would have drawn no interest if put up for sale due to them being uneconomic to develop in a low-commodity price environment.

In addition to the recurring questions relating to borrowing bases and paths to address deficiencies, each Haynes and Boone redetermination survey also asks one topical question.  For the spring 2017 survey, the topic question is: What percentage do you expect E&P capital expenditure budgets to change in 2017 as compared to 2016?  An astounding 89 percent of respondents said that capital expenditure budgets will increase in 2017, with 8 percent saying there will be no change to budgets and only 3 percent saying there will be decreases in budgets.  Not only do a significant number of respondents expect drilling budgets to increase, they also expect these increases to be significant. Nearly two-thirds of respondents expect that capital expenditures will increase by 20 percent or more in 2017 as compared to 2016.

The optimism regarding drilling and other capital expenditures is not entirely surprising.  After the sudden oil price drop that resulted from OPEC’s November 2014 decision not to cut production, many industry analysts predicted a significant number of producers would not survive.  There was certainly massive destruction of capital in the two years that followed (especially with respect to the value of junior debt and equity).  Still, many industry participants believe that the U.S. oil and gas industry has been more resilient than expected.  The cautious optimism seen with respect to bank financing for energy companies has perhaps translated into a bullish optimism with respect to capital expenditure budgets.

What remains to be seen is whether the market is properly balancing out the oil oversupply situation and, more importantly, whether the borrowing base and capital budget optimism will result in too much new U.S. oil supply too soon.  For every analyst that reports reductions in supply and inventory (and thus future price improvement) there is an analyst that sees supply increase and downward price pressure in the future.  Stay tuned for Haynes and Boone’s fall 2017 survey to see if the optimism of 2017 continues or the pessimism of 2015 and 2016 returns.