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Reserve-based-lending fades in financing of upstream oil and gas

As political pressure on traditional lenders continues to grow the oil and gas sector is having to get creative with financing sources. What’s the current state of this vital part of the M&A equation, and how will that change over the rest of the year? Investors from both sides of the table get together to discuss the challenges and solutions for oil and gas companies looking to access the debt capital markets. 

Reserve-based lending (RBL), a form of asset-based lending that has been the backbone of financing upstream oil and gas production and M&A, is starting to slip away as an option after years of volatility and low commodity prices, according to speakers at the Mergermarket Energy M&A Forum on 3 December.


Video: Financing the fields

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    Patrick Gimlett Managing Director, AB Private Credit Investors at Alliance Bernstein
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    Grant Butkus Managing Director, RBC Capital Markets
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    Mary Kogut Brawley Partner, Kirkland & Ellis
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    Tom Davidson Assistant editor, Mergermarket

"I think what we’re going to start to see is a gradual shift towards alternative, more permanent capital filling the role that the RBL used to play," said Mary Kogut Brawley, a partner at Kirkland & Ellis. "It certainly is still an important spot for commercial banks in that market. E&P companies still needs LCs, they still need hedges, so there is still a place for the commercial banks. I think we’ll still see adaptivity. but I just think the RBL product as we know it, we will start to see less and less of that and start seeing more of the permanent capital come in."

Grant Butkus, managing director at RBC Capital Markets, said that while his institution is still supportive of the oil and gas industry, other banks are pulling back or completely leaving the sector. Even maintaining borrowing bases can be a challenge, and accessing additional capital through RBL “has a very high bar".

"There is a whole suite of options out there for companies to access," Butkus said. "It’s just going to take a little more work and a little more thought in order to put in that permanent or semi-permanent capital as they think through how do they work through a much smaller RBL going forward."

Patrick Gimlett, managing director of AB Private Credit Investors at Alliance Bernstein, noted that RBL was initially intended as a way for upstream companies to quickly finance growth opportunities in an asset base. But that came at a time when simply growing reserves for the sake of growth was the biggest priority for much of the sector. Today, the industry has shifted to prioritize creating free cash flow and profitability as commodity prices have stayed low.

That change in focus, also fueled by the frustration of investors who have seen the sector underperform since 2005, means lenders are evaluating opportunities differently, Gimlett said. Banks and alternative investors like he represents have started adding terms that limit how much cash flow from an asset can be reinvested into growing production, requiring more hedging of commodities for longer periods of time and other language that helps reduce risk for lenders.

All three panelists agreed that high-quality E&P companies offering higher yields on bonds can still access capital, as investors are intrigued by such opportunities at a time when interest rates are so low.

Kogut Brawley said she has seen companies pursue funding structures such as DrillCos and junior lien transactions to finance work, and she added that more creative ideas are being explored. Upstream companies looking to access capital should build in enough time to explore both RBLs and the menu of options outside of it, she said.

"Start early," she said. "It’s going to take longer than it did in the past."

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