The Examiners: Weakened Companies Failed to Manage Risk

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?

Whether precious metals, industrial chemicals, oil and gas or electricity, commodities have seasonal, short-term and secular, long-term cycles. These patterns are complex and difficult to predict under the best of circumstances. Moreover, the inherent volatility of the spot markets for commodities significantly amplifies the impact of exogenous variables such as politics and public opinion, market liquidity and manipulation, speculation and a lack of transparency to forward markets. Given the interactions of this multiplicity of variables, prognosticating future commodity prices is a fool’s errand, generally relegated to an “industry expert.” Forecasts prone to bias, affording limited insight, are seldom accurate.

The fortunes of oil and gas producers are significantly tied to commodity prices; operating and financial leverage magnifies these impacts. As a result of the precipitous decline in the price of both oil and gas in the past several months, one respected credit bureau anticipates that 55 of these companies face near-term restructuring. The common denominator among these candidates is failure to manage commodity price risk. Whether these “walking wounded” file for bankruptcy will depend primarily on the duration of the currently depressed pricing environment as well as on lenders’ good graces.

The special issue confronting courts in the bankruptcies of such commodity-based companies is a determination of future prices and means to adjust recoveries given the likelihood actual prices will deviate. In addition to settling on a reasonable composite forecast, it has proven appropriate and necessary in precedent cases to incorporate in plans of reorganization securities that afford key stakeholders varying recoveries through warrants or other contingent rights as compensation for material price movement currently unanticipated by “conventional wisdom.”

Anders J. Maxwell is a managing director in the restructuring & recapitalization group at New York-based investment banking advisory firm Peter J. Solomon Co.