?Liquidity, previous hedging, low debt, declining costs and capital-spending discipline are among the key features of a strongly positioned E&P, according to Jeff Morrison, associate director of corporate and government ratings, with Standard & Poor’s debt-rating service. Also key is the E&P’s use of asset sales to further bolster the balance sheet.


The attributes Morrison cites are mitigating factors against declining commodity prices, reduced access to debt or equity capital, upcoming borrowing-base redeterminations, covenant violations and overspending cash flow.


Morrison made his observations recently in a webinar, “Seeing Through To Solutions: The Economic Downturn’s Impact On The Energy Industry,” which was hosted by Oil­andGasInvestor.com.


“Cash-flow adequacy is an area in this market we are certainly focusing on now,” Morrison said. Among the 44 E&Ps whose credit quality S&P rates, one is rated “A” and 30 are rated “BB” through “B-,” or generally in the high-yield category. S&P’s analysts have issued 15 negative high-yield E&P rating actions so far this year.


“Liquidity is something we’re really placing a premium on right now.”


Greg Kerley, executive vice president and chief financial officer for Houston-based Southwestern Energy Co., offered his company’s current financials as a baseline example of a well-positioned E&P. “We are a bit of an anomaly in that we don’t have borrowing-base redeterminations…through 2012,” Kerley said. Its $1-billion credit facility is unsecured, and is undrawn.


The Fayetteville-shale-focused producer has some $200 million of cash on hand. Its $600 million of senior notes are at 7.5% and are not due until 2018, and its year-end 2008 debt-to-total-capitalization ratio is expected to be some 23%. The company has put no new production hedges in place, and the remaining hedges—approximately 48% of its 2009 production—are at an average floor of $8.48 per thousand cubic feet. By operating about 90% of its production, its can control spending, up and down, he added.


Michael D. Bodino, director of research and senior E&P analyst for the SMH Capital institutional equity research group, suggests that investors seeking clues to the best-positioned E&Ps in a total-downturn marketplace should keep sight of red flags. “There are a number of companies that are precariously positioned. Watch for the following warning signs that keep us up at night.”


• Spending more than cash flow or having to make a sizeable investment to convert a project to cash flow. These E&Ps may still be drawing down a borrowing base. “Those that have to borrow give us the most concern into this downturn.”


• No dry powder. Poor project economics. These E&Ps may be continuing to pursue projects with mediocre or poor rates of return.


• High debt-to-cap and high debt-to-EBITDA. Difficult capital structures and/or unpalatable terms in bond indentures or bank covenants. High G&A as a percentage of revenue. High F&D costs and poor investment returns.


• Positioning in the wrong basins, e.g. the Rockies or Gulf of Mexico. “Gulf of Mexico companies need 70% to 80% of cash flow to replace reserves.”


• A short reserve life, which is a higher risk in a period of declining commodity prices.


• A high percentage of PUDs (proved, undeveloped reserves). “You start getting an aging-of-PUDs issue where you can’t develop them in a period of time in which they are valuable.”


• Long acreage and short capital. “Don’t be fooled.”


• Negative growth rates, as shrinking companies typically mean shrinking capital and smaller valuations.


Solutions include refinancing; monetizations, including VPPs, farm-outs and joint ventures; strict cost management and at worse, a merger or sale. “I certainly expect to see more M&A activity this year,” he said.
“The silver lining? The average (commodity-price) down-cycle since 1970 has lasted an average of 18 months…The next upturn begins again in earnest in 2018.

Comments