The Examiners: Prices Will Create Ripple Effects Through Industry

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 recent volatility in crude oil prices may cause exploration and production companies to temper their production efforts and maximize their liquidity by reducing their capital investments, which could have a corresponding ripple effect throughout the oil production supply chain.

For example, there could be near-term negative repercussions for oil field service providers and rig operators, who both provide personnel and equipment for the onshore and offshore exploration and production companies.

Revenue for these service providers is tied to the amount of oil that is produced, not the price at which it is sold. Therefore, if less oil is being produced due to an oversupply in the market, then over-levered service providers are most at risk for near-term liquidity issues and related covenant defaults, as exploration and production companies try to modify day rates in order to maintain margins.

The slowdown in exploration and production efforts will similarly affect those who support the oil field service providers, such as the companies who lease equipment to and subcontract with the providers. Such companies will face the prospect of being unable to service the debt on their underutilized equipment.

By comparison, the stress on the exploration and production companies will take some more time to manifest itself. To the extent a producer has been able to put hedges in place to protect against future market volatility, that company will be better positioned to continue its scheduled output without too much disruption.

Producers aren’t the only ones adjusting to this new normal. Lenders, whose borrowing base is tied to the borrower’s proven oil reserves, may be willing—at least in the short term—to provide their borrowers with some covenant flexibility as the borrower’s proven reserves are revalued this spring to reflect the market’s current prices.

We are more likely to see near-term, in-court restructurings for those exploration and production companies and service providers whose liquidity problems began in 2014, who are having difficulty obtaining new financing or selling their assets or who are pursuing some other transaction to resolve those issues.

Recent examples include Quicksilver Resources and Dune Energy. Quicksilver’s filing was precipitated by the volatility of commodity prices, together with the uncertainty in the oil and gas markets, which hindered its efforts to effectively market its assets and pursue a solution outside of bankruptcy. Similarly, for Dune Energy, a potential merger partner wasn’t able to obtain the requisite financing to close the merger due to the severe decline in the price of oil. Without a merger partner, Dune faced an imminent liquidity crisis that was best addressed through an in-court restructuring.

Undoubtedly, stress will continue to be felt throughout the oil and gas industry in the next 12 months.  But this also presents an opportunity for over-levered companies to restructure their balance sheet in time to take advantage of a correction in oil prices.

Brett Miller is the managing partner of the New York office of Morrison & Foerster LLP, where he is a partner in the business restructuring & insolvency group and co-chair of the distressed real estate group.