The Examiners: Restructurings Won’t Be Extreme

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 decline in oil prices has put substantial strain on many exploration and production companies as well as industry service providers. The question of how many exploration and production and related companies will need to restructure is the focus of myriad analyst reports, and investment funds around the globe are analyzing ways to profit (or reduce losses) from the steep drop in the price of oil.

While a number of exploration and production companies will need to restructure in the near term and a handful of companies have already sought bankruptcy protection, the severity with which these companies and their service providers will need to restructure likely will not be extreme. Most companies in the industry have curtailed plans that would have required significant capital expenditures and have sufficient liquidity and hedging arrangements in place to help them attempt to ride out the current storm until prices recover in this cyclical industry.

On the other hand, creditors of distressed exploration and production companies will be keenly focused on ensuring that such companies don’t attempt to ride out the storm on their backs and at the expense of their potential recoveries. If prices don’t recover in the next 12 months, liquidity issues will likely increase, likely resulting in more restructurings.

For oil and gas companies on the cusp of restructuring, early planning is paramount for the companies and their stakeholders.

Indeed, there are a number of issues unique to oil and gas companies that require particular focus and the assistance of legal and financial advisors with expertise in the energy, restructuring and regulatory fields. While many issues germane to an exploration and production restructuring and stakeholder recoveries appear similar to those present in other industries—valuation, financing, lease/contract analyses, critical vendors, secured claims and the extent of unencumbered assets—addressing them requires specialized knowledge.

For example, financing is typically reserve-based, with the amount and terms predicated on the projected cash flows from production. Reserve values are affected by a number of factors, including location and assumptions regarding production rates, decline curves, operating expenses and, most importantly, the “price deck” applied to future production.

The extent to which reserves are encumbered by pre-petition liens similarly impacts the availability of financing in addition to unsecured or undersecured creditor recoveries as many times there are valuable unproved reserves that aren’t pledged as collateral to pre-petition lenders.

Also, the exploration and production company’s ownership position in its leases should be carefully considered in any financing and related restructuring. The path to the company’s net revenue interest in a lease is often complicated and may not be reflected fully in a schedule that a company provides.

Further, the financial stability of the other working-interest lease owners also may be relevant to reserve valuation.

Other issues particular to exploration and production companies include the timing of royalty payments and whether the related interests constitute real or personal property.

This represents just the tip of the iceberg of issues specific to exploration and production company restructurings, evidencing the need for experts in energy and restructuring to assist oil and gas companies and their stakeholders in navigating through the industry’s current cycle.

Philip C. Dublin is a partner at Akin Gump Strauss Hauer & Feld LLP in New York, where he concentrates on creditors’ rights, corporate restructurings and bankruptcy law.