[Editor's note: A version of this story appears in the April 2020 edition of Oil and Gas Investor. Subscribe to the magazine here.]

Randall L. Osterberg sat with his back to the escalator at the Hilton Americas hotel, nursing a cup of Starbucks’ finest fully synthetic and ruminating on M&A in the time of the coronavirus.

Osterberg, managing director at Opportune LLP, has had time to consider the bad bounce the industry has taken since his banker days arranging credit facilities for Aubrey McClendon and Chesapeake Energy Corp., Continental Resources Inc. and HollyFrontier Corp.

Osterberg blames the unending buffet of money for the folly that’s befallen the industry’s dealmaking. Like the housing market’s subprime mortgage crisis in the previous decade, lenders signed up credit-damaged borrowers who couldn’t pay.

Many E&Ps turned out to be unworthy, too. “All the money needed a home,” he said. “So, they create this stuff. The industry had some bad investments just because the money was there.”

In the McClendon days, most people chased the companies. Osterberg chased private equity. “The big theory—what it’s always been—is you chased the money. Where is the money?”

The Chesapeake portfolio grew large, from multimillion-dollar loans to billions and then more billions. Osterberg sees the company as the spark behind the pre-downturn M&A market, with assets flipping to McClendon or one of the always-acquiring MLPs that seemed to buy anything in their path.

Osterberg recalled visiting the smaller, private-equity teams to discuss how the teams planned to exit. “What’s your exit strategy?” he would ask.

In many cases, the companies had a single offramp in mind: “Sell to Chesapeake,” they would say.

But that was a long time ago. The days of flipping assets long gone. The old ways of proving up an asset over time and great effort have returned while the quick paydays have vanished like reserve-based lending values.

“I mean it’s not sexy. They’re just doing [it] the old way again,” he said. Lately, M&A is a mess. Market dysfunction swirls as buyers hunt for PDP assets with discounts of PV-20 or higher on their minds.

“You’ve got these guys who see blood in the water,” he said. Elsewhere, there are still operators coming to terms with the idea that no one will pay for upside. “A healthy M&A market is what we’re all looking for,” he said. “But you can’t get there because the bid and the ask are too wide.”

Among the hindrances to buyers and sellers is the basic disagreement on asset value, with sellers maintaining a higher value for leasehold than can be reasonably justified, in Osterberg’s view. Even when potential buyers offer prices in line with market values, the distance between buyer and seller remains far too wide.

After reviewing one deal, Osterberg found no equity value in the assets, the bank was under water and most of the management team’s equity was wiped out.

“There are people who just need to capitulate,” he said.

But Osterberg, as a former banker, said the more fundamental question is how close lenders are to giving up.

A day will come, perhaps sooner than later, that a bank holding a foundering upstream company’s debt chooses to simply foreclose rather than running another iteration of forgiveness that produces the same result.

“The banks are going to say [they] want to liquidate my assets in this market, which is a crummy M&A,” he said. “Can I extend the runway by working with the current management team and keeping the assets?”

E&Ps that continue to operate and at least maintain production live to fight another day.

Osterberg is already seeing the emergence of contract operators—old private-equity teams that are still together but displaced from a failed private-equity venture. A faltering company could give them an opportunity restart.

Banks haven’t made the move yet.

But, “we all feel like that first time when the bank actually forecloses the assets, then everyone can point to it. ‘It’s been done. Here we go.’”

Until then, equity is continuing to get wiped out. Banks are under water. And management teams still operate, “because they’re at least still getting a paycheck.”

“This is the worst time I can ever remember where banks have limited optionality,” he said.

After about an hour, Starbucks untouched, Osterberg recalled a conversation with a former boss, a banker who couldn’t believe his institution was losing money in oil and gas. Historically, “you don’t lose money on oil and gas. You just don’t do it,” he said.

“Of course, we do it pretty regularly now,” he said.

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