DALLAS – Bankers eager for a deal and E&Ps salivating over potential assets on the selling block may have to wait longer than they’d like for a deluge of hot assets to hit the market.

There are roughly half the number of public upstream companies today relative to 2016, and most have far stronger balance sheets, said Will Hodge, managing director and co-head of E&P at Raymond James, during the ‘Buy Side/Sell Side Perspectives’ panel at Hart Energy’s Energy Capital Conference on Oct. 3.

In short, those companies don’t need to speed through an A&D process, taking whatever they can get for assets they’ve acquired but not fully vetted, simply to lower their debt profile. It’s a more measured approach to past cycles that could benefit the industry across the chain of its finance.

“I think we're all optimistic that the A&D market picks up mainly from portfolio rationalization early next year or [the next] two, and I think the private credit market's going to benefit from that,” he said.

Market consensus is that the industry’s portfolio capitalization will take place during the next two to three years, he said. And it will be a lot of activity. But first, the consolidation rationalization phase takes place, and some large cap companies have forecasted that while momentum exists, they don’t necessarily have a sense of urgency to make deals.

“Talking to a lot of private equity clients, they're looking for that to happen as well. I think credit providers and other capital providers are looking for that to happen, but there's not the same catalyst there used to be as far as balance sheet pressure,” Hodge said. “Most of the large caps are very strong from a balance sheet perspective, and so there is some question in regard to timing and how quickly they go through that portfolio rationalization.”

Still, there’s so much momentum that key players, capital providers and private equity are pushing for portfolio rationalization, he said.

“When I meet with those large caps and their boards, they're definitely starting to think about it and understand that it should happen over time, but again, we'll be interested to see how fast it unfolds,” Hodge said.

Thriving in chaos

Institutional investors’ flight from the oil and gas industry has created an opening for alternative sources of capital to step up, said panel moderator Chad Nichols, a partner in the Houston office of Gibson, Dunn & Crutcher where he is a member of the finance and business restructuring/reorganization practice groups.

Both the type of credit that is needed and the function of capital markets have shifted since Nicholas Fersen co-founded EOC Partners in 2022, he said.

“In private credit, there's kind of a lull in 2024. We're in this ‘Goldilocks’ period, where the bank market is functioning [and] the high yield market is robust. You're seeing private companies—Aethon [Energy], Kraken Resources, Wildfire Energy, all private companies—access the high-yield market. It's sub-8% coupon. It's cheaper than their bank revolver,” Fersen said. “When the-high yield market is functioning like that, I think private credit takes a backseat.”

In addition, Fersen said, the U.S. bank market for oil and gas is “fairly robust” for the first time since COVID, at least in part because the European banks’ exit from the space means there are fewer players.

The consolidation impact cannot be overstated. Not only has it decreased the number of companies looking for capital, but the companies that are merging—Fersen referenced the $7.4 billion combination of Chesapeake Energy and Southwestern Energy to form Expand Energy—don't need to access 2x or 3x the value of their revolvers.

“And so, bank portfolios have shrunk,” Fersen said, adding that from his vantage point, it appears that banks’ loan books are between 33% to 50% less their 2022 value.

Coming out of COVID in 2022, when EOC was founded, there was little indirect lending, he said. Almost three years later, there are significantly more participants.

Moreover, the private credit market is functioning well, he said.

“Private credit's got this golden age where the [private equity firms] Apollos and the KKRs in the world, they're partnering with Citibank on the direct lending side, and that market is so frothy that there's not as much opportunity there,” Fersen said. “They're starting to peak over the fence and we're starting to see some of what I consider the generalists come back into the space. It'll be interesting to see whether those generalists actually come back in or they're kind of dancing around the edge.

“But right now, if you're a company, you've got a wonderful functioning bank market [and] high yield market.” he added.

Fersen said the oil and gas business “thrives in chaos.”

“We're just kind of sitting and waiting, and inevitably in this industry something will happen,” he said. “Either oil will go to $50 because of the Saudis, or the high-yield market breaks because of existential macro factors that have nothing to do with energy.”

Reoriented for growth

“You’ve seen a lot of banks that are now reoriented towards loan growth and doubling down on their covered industries,” said Daniel Hoverman, head of corporate and investment banking at Texas Capital. “I would say the bank market is healthy, but it is still at, I think, a more conservative attachment point. One of the things that I would note about private credit: We've had some notable success in placing capital where we come in and lend with a smaller bank facility and a larger institutional capital structure.”

Hoverman said that a persistent challenge remains: a deficit of capital relative to capital needs. That represents a challenge for fund managers coming to the space and serving the market.

Nichols added that there’s “no longer the idea that you can just have a revolver and RBL [reserve-based lending] and be at 4x or 5x leverage.”

“It seems like I'm seeing two and a half, three times and a lot more deals, and even that's kind of high,” Nichols said. “Hence the importance of private credit coming in or high-yield debt for that matter, and kind of providing a company with leverage that they might need.”

At the end of the day, Hoverman said, “it comes down to risk management.”

“The reality is in this bank market, the revolver may be sized small enough that you don't necessarily need hedging and other requirements because you would've passed through some minimum funding threshold on a much larger facility,” he said. “I don't think that the fundamental approach to credit underwriting has changed as much as the structure and the mix of capital within the facility,”

Raymond James’ Hodge said most are optimistic that the A&D market picks up from portfolio rationalization in the next year or two.

“And I think the private credit market's going to benefit from that,” he said.

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