Opportunity
The complete collapse in oil prices over the past seven months has dramatically changed the investment environment in the United States for Oil and Gas Exploration and Production. Investment capital, including Wall Street, was throwing money at projects and oil companies seemingly without completely understanding the risks inherent in the E&P space. There were a lot of projects that should have never been funded and as a result significant capital will be lost. In the recent past, the least expensive way to enter/invest in the oil business was through the drill bit; as purchasing current production had become extremely expensive. We encountered prices as high as $150,000 per barrel produced. This translated into over a 4 year breakeven period at $100 a barrel, which was not even taking into account taxes, royalty payments and production declines of the well. With oil below $50 a barrel, the breakeven period moves to over ten years. Anybody who paid those prices is seriously underwater or bankrupt if they used leverage to purchase the production. Many operators used borrowed capital to fund their operations be it production, leasing, drilling (conventional and unconventional). They borrowed the funds based on future production or proven reserves of oil at $100 a barrel valuation. With oil currently below $50 a barrel they need to sell assets to bring themselves back in line with bank covenants or in many cases they will be forced into bankruptcy and liquidated. When an operator/producer is financially stressed or in liquidation the most liquid assets are sold first. In the oil and gas industry the most liquid asset is production. It has a known risk profile and cash flow and is the least risky way to invest when the payback period is short in duration. We believe that assets all across the oil and gas risk spectrum will be for sale in the next six months as banks and other lenders “mark to market” the assets that are securing loans. Banks have zero wiggle room due to The Sarbanes – Oxley Act and a lot of operators will be surprised at how quickly the banks will want money to shore up collateral. There will be a lot of forced asset sales to bring companies in line with their bank covenants. We have heard, anecdotally, that there is over $200 billion of junk debt tied to the shale space alone. Publicly traded E&P companies and MLP’s stock prices have experienced huge declines making it impossible for them to raise cheap capital in the debt and equity markets. Traditional lenders, such as banks, already have far too much exposure in the oil patch and will not be lending money for asset purchases. We think they will be net sellers. This removes a lot of the competitors in the marketplace that have traditionally been asset buyers. If oil and gas prices stay near the current price levels, the amount of capital available to buy distressed assets will be greatly diminished creating a perfect opportunity to those that have cash and the relationships in the industry.
The complete collapse in oil prices over the past seven months has dramatically changed the investment environment in the United States for Oil and Gas Exploration and Production. Investment capital, including Wall Street, was throwing money at projects and oil companies seemingly without completely understanding the risks inherent in the E&P space. There were a lot of projects that should have never been funded and as a result significant capital will be lost. In the recent past, the least expensive way to enter/invest in the oil business was through the drill bit; as purchasing current production had become extremely expensive. We encountered prices as high as $150,000 per barrel produced. This translated into over a 4 year breakeven period at $100 a barrel, which was not even taking into account taxes, royalty payments and production declines of the well. With oil below $50 a barrel, the breakeven period moves to over ten years. Anybody who paid those prices is seriously underwater or bankrupt if they used leverage to purchase the production. Many operators used borrowed capital to fund their operations be it production, leasing, drilling (conventional and unconventional). They borrowed the funds based on future production or proven reserves of oil at $100 a barrel valuation. With oil currently below $50 a barrel they need to sell assets to bring themselves back in line with bank covenants or in many cases they will be forced into bankruptcy and liquidated. When an operator/producer is financially stressed or in liquidation the most liquid assets are sold first. In the oil and gas industry the most liquid asset is production. It has a known risk profile and cash flow and is the least risky way to invest when the payback period is short in duration. We believe that assets all across the oil and gas risk spectrum will be for sale in the next six months as banks and other lenders “mark to market” the assets that are securing loans. Banks have zero wiggle room due to The Sarbanes – Oxley Act and a lot of operators will be surprised at how quickly the banks will want money to shore up collateral. There will be a lot of forced asset sales to bring companies in line with their bank covenants. We have heard, anecdotally, that there is over $200 billion of junk debt tied to the shale space alone. Publicly traded E&P companies and MLP’s stock prices have experienced huge declines making it impossible for them to raise cheap capital in the debt and equity markets. Traditional lenders, such as banks, already have far too much exposure in the oil patch and will not be lending money for asset purchases. We think they will be net sellers. This removes a lot of the competitors in the marketplace that have traditionally been asset buyers. If oil and gas prices stay near the current price levels, the amount of capital available to buy distressed assets will be greatly diminished creating a perfect opportunity to those that have cash and the relationships in the industry.