It seems that lower oil prices are here to stay, at least in the short to medium term. While some in the sector built cash reserves during the boom years or have already renegotiated with their creditors, several are looking at some form of restructuring. This can range from opex/capex reductions to balance sheet restructurings. Here are seven questions that oil and gas sector management (particularly the general counsel and chief financial officer) should consider when considering a restructuring:
Who holds the power in your balance sheet?
Where does the value ‘break’, ie how do the layers of debt and equity on the balance sheet stack up compared to the estimated enterprise value of the group? If the value break is in the debt (implying the equity has no value), investors with positions at or around the break will have the leverage in negotiations, and may be looking to flip their debt position into a control position – the typical move of a ‘loan-to-own’ investor. Out of the money investors will have little power unless they team up with those at the line. But even if those at the value break are co-operative, what will the new shareholding structure look like after the restructuring? Will the new shareholder base be supportive of the business after the restructuring, or is this just the next step to monetisation?
Do you have to disclose, and if so, when?
Companies with public securities (debt or equity) will have duties to disclose price-sensitive information. It is a judgement call as to whether delaying disclosure of an impending restructuring is protecting the interests of the company or misleading the market, but any announcements that are made should be carefully worded so as not to create false impressions – this can be tough to fight for in an industry that loves to shout good news. A GC will need to make sure that its record keeping and corporate housekeeping are up-to-date and accurate in order to manage the information flow appropriately. In periods of high sensitivity, it is also important to keep the restructuring team as small as possible and on a restricted list to prevent leaks. The restructuring team (and all advisers) should be prohibited from trading in company securities until the restructure is announced.
What impact does the new environment have on your borrowing?
For companies with a reserved based lending facility (RBL), the fall in oil price and consequent reduction in commerciality of reserves will not be welcome. RBLs typically provide for at least an annual, and often twice annual, redetermination of the resource base, so many exploration and production operators over the last 18 months may have taken, or will soon be forced to take, a haircut on what funds are available to them. Before commencing on any debt restructuring, borrowers should stress test their asset valuations and resource base so that negotiations are not forced to change direction in the event of a revision downwards.
Any announcements that are made should be carefully worded so as not to create false impressions – tough to fight for in an industry that loves to shout good news.
Further, loan agreements typically contain an early warning mechanism through financial covenants, breach of which will alert lenders to a distressed situation, since they will have to waive a breach of that covenant. Borrowers will need to consider whether they are still able to give ordinary course repeating representations, such as solvency, both to lenders and to their auditors.
Can you push out your debt?
For those with bonds who are looking to manage larger liabilities, it could be possible to extend maturities without committing to a broader restructuring. Bondholders can often be tempted with higher yields, and while the costs of borrowing, together with any related fees, are likely to go up, an exchange offer for higher-rate/longer-term notes could provide breathing space without having to incur the additional time and costs of a refinancing. For those who issued notes at high rates that are now trading well below that yield, it could be worth trying to buy back these notes at a discount. Assuming the company can get comfortable with its liquidity, buying back notes at a discount is immediate profit.
What is the impact across core contracts?
The core contracts that comprise the underlying assets of any oil and gas
company, from people with significant control (PSCs) or joint operating agreements (JOAs) in an upstream context down to transportation, offtake or refining agreements further down the value chain, will likely contain provisions that may be triggered by a restructuring. Before deciding on a course of action, these contracts should be reviewed to determine the options that are open to the business. For instance, PSCs may be in default if production is suspended other than for force majeure, and default remedies, including forfeiture of interests in some jurisdictions, may be exercised against a non-performing JOA participant. The 2012 Association of International Petroleum Negotiators model JOA also allows for the removal of the operator where an assignment is made for the benefit of creditors, or upon a change of control, and, similarly, the standard BP terms for sales and purchases of crude allow for termination in the event that a party enters into an arrangement or composition with its creditors. Clearly, any restructuring plan that puts the most fundamental contracts of the business at risk is not worth pursuing, unless there is no alternative.
What does the profile of decommissioning liabilities look like?
Decommissioning liabilities at the end of a well’s life can be significant. If the party holding the working interest in the relevant PSC or licence is not of sufficient financial standing, parent company or bank guarantees may be required so that the relevant authorities have assurances these liabilities will be met. Entities undergoing material restructurings need to ensure this remains the case; if there is any risk that such liabilities cannot be met, supplemental guarantees or bonds may be required. Early abandonment of declining fields could also trigger unwanted decommissioning liabilities, which only contribute further to the company’s difficulties.
When should the directors switch their focus?
If, despite best efforts, insolvency looks likely, the directors may need to consider not only the success of the company as a whole and the interests of its members, but also give more direct consideration to the interests of creditors (such as under s214 of the UK Insolvency Act or state law in the US). It is no good simply trying to spend your way out of trouble or embarking on a complicated restructuring when there is no reasonable prospect of avoiding liquidation. At this point, a GC must advise their board that they should take every step to minimise potential loss to creditors, or they risk substantial personal liability. Throughout the process, retaining appropriate directors and officers liability insurance will be essential.