The Examiners: Distress Trend Will Continue as Prices Remain Low

How much stress can we expect to see for oil and gas producers and related companies as a result of the current low prices? And what special issues does this industry face when it’s time to restructure or file for bankruptcy?

The U.S. shale oil boom fueled by hydraulic fracturing has been a double-edged sword. Due to the pace of domestic crude oil production, the U.S. has become the world’s largest producer of oil and natural gas liquids in 2014. At the same time, and partially as a result, oil and gasoline prices have plummeted. While this is good news for individual and business consumers who rely on the commodity, it has quickly become a nightmare for producers, oil field service companies and their lenders and investors.

“Fracking” is a much more expensive means of extraction than traditional drilling methods—by some estimates and depending on particular circumstances, more than twice as expensive. High production costs, depressed prices, limited liquidity, high leverage and costly junk-bond debt (characteristics of many producers) are a recipe for financial distress, and the evidence is plain in recent headlines trumpeting the instability or demise of small and large producers alike. This trend will continue if oil and gas prices remain depressed.

If a producer decides (or is forced) to seek bankruptcy protection, it faces a number of thorny issues that are largely unique to the industry due to the way that oil and gas production relationships are structured among producers, holders of mineral, working, royalty or net profit interests, lenders and investors.

The various stakeholders involved face uncertainty, due to disparate treatment of oil and gas interests under state law, as to whether such interests will be treated as: (i) transfers of real or personal property, such that the property transferred is part of the interest holder’s bankruptcy estate (ii) financing arrangements; or (iii) “executory” leases that can be assumed, assumed and assigned, or rejected by the debtor or a bankruptcy trustee. These and other related issues remain unsettled among the handful of courts that have addressed them. A number of pending oil and gas company chapter 11 cases will provide courts with an opportunity to address at least some of these unsettled issues. Other unique aspects of oil and gas workouts include managing plugging and abandonment liabilities and the favorable statutory lien rights granted to vendors in the oil patch.

Finally, dark clouds for producers may contain a silver lining for potential investors in or acquirers of distressed oil and gas assets and debt. Many see opportunities in companies that, with or without assistance in the form of restructuring or additional capital, can weather the storm until oil and gas prices make an inevitable resurgence.

Paul Leake is a partner in Jones Day’s New York office and the global practice leader of the firm’s business restructuring and reorganization practice.