Energy Rules are Being Fundamentally Rewritten

Apr 13, 2015
Hilco Global's Jack Butler discusses Oil & Gas Industry in his latest WSJ Examiners article.

How much stress can we expect to see for oil and gas producers and related companies as a result of the current low prices? And what special issues does this industry face when it’s time to restructure or file for bankruptcy?

The sobering reality about the current price collapse in the global oil and gas markets is that it’s driven by fundamental changes in both supply-side and demand-side factors—and underlying market conditions suggest that prices are likely to stabilize well below the near-high watermark experienced in recent years.

On the supply side, rising North American supplies created by the increased sophistication, adoption and use of U.S. light tight oil extraction technologies, commonly known as hydraulic fracturing or fracking, are transforming the roles and relative power of OPEC and non-OPEC producers. On the demand side, factors ranging from lower demand by emerging economies to the politics of climate change and related regulation to the impact of globalization and the commercial feasibility of alternative fuels are reducing the demand rate.

Event risks like increased fracking industry regulations and political disturbances globally foreshadow continued volatility in future energy prices. However, it seems relatively certain that under any scenario, the rules of the energy supply and demand game are being fundamentally rewritten. These changes will create new winners and losers and will disrupt business enterprise and asset valuations in the short and intermediate term. Industry disruption experienced over the last year has played havoc with operators, causing suspension of operations, layoffs and loss of key personnel, negative cash flow and, in some cases, judicial reorganizations and liquidations.

Many operators have implemented short-term survival plans that, among other initiatives, reduce capital expenditures at the expense of longer-term cash flows. These stop-gap efforts not only compromise business enterprise valuations but also may not be sustainable in the headwinds of rising interest rates and only moderate price recovery.

The ripple effect of the current distress cycle has extended to service providers and other businesses in places where energy production is a principal business. Energy industry distress is also reflected in significant reductions in the trading prices of public energy company debt as well as in reduced availability in borrowing bases under reserve-based revolving credit facilities. Unless these trends moderate, the cost of capital in the energy industry will continue to increase and available liquidity will decrease causing some companies to experience liquidity crises and others to consider judicial restructurings or even cessation of operations and liquidation.

Exploration and production companies face a number of complex, industry-specific issues when considering chapter 11 reorganizations. Chief among these is whether the energy interests are classified as real property interests or as unexpired executory leasehold interests subject to assumption or rejection.

What law controls such determinations? How will bankruptcy courts adjudicate the bankruptcy code’s safe harbor provisions affecting production payment sales and whether the payments are included or excluded from the debtor’s estate? And how will other unique industry issues that are certain to influence energy reorganizations be resolved, including issues surrounding joint operating agreements, priority of payment for decommissioning liabilities associated with suspended and abandoned operations and the validity and priority of contractors’ statutory liens?

Companies seeking to restructure their businesses will also face expansive and expensive due diligence examinations from lenders, statutory committees and investors anxious to discern whether all of the debtor’s leases and other agreements have been properly documented to preserve counterparties’ claimed superior rights in specific asset streams.

The new economic reality in the energy industry will create new winners and losers. Those companies depending on short- or intermediate-term price recovery for their financial solvency likely will be required to pursue comprehensive restructurings. They will face complex and unique restructuring challenges that must be carefully navigated in order to maximize stakeholder value and recoveries.

Jack Butler is executive vice president with Hilco Global, where he works with healthy and distressed companies, their creditors and investors on a broad range of strategic transactions.

 

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Source: Wall Street Journal