For more in depth analysis on Pinsent Masons' research on oil and gas services, see our Ahead Of The Curve special reports.
Although 84% of respondents to recent research on behalf of Pinsent Masons, the law firm behind Out-Law.com, told us that they planned to fund deals from their own cash reserves, over half planned to rely on bank funding or use a mixture of cash reserves and loans. The oilfield services professionals we surveyed were confident about their ability to take out bank loans despite the sector's high capital requirements, and the fact that many of these businesses are already overleveraged with debt.
However, at the banking end of these potential transactions, the results were less optimistic. During our research, seven out of 10 of the most prominent banks operating in this field told us that they would not feel comfortable lending at an oil price below $60-$70 per barrel. As of January 2016 the price had fallen still further, to below $30 per barrel.
Although there will be some exceptions, particularly for higher value transactions involving the global players, the commercial reality is that market participants may need to look elsewhere for finance. As banks tighten their lending criteria they may have to turn to public markets and equity financing and accept the extra pressures from shareholder scrutiny that those funding mechanisms bring.
The view from the industry
Our survey findings show an industry optimistic about M&A prospects, with 86% of respondents expecting a surge of deal activity in the next 12 months and 70% actively considering making an acquisition of their own. The clear majority are also ready to use their own cash reserves to get the right deal, giving them leverage in any price negotiations and allowing them to avoid the more complex ownership structures inherent in debt financing.
Once cash reserves, supported by 84% of respondents, were exhausted, 58% said that they would turn to bank funding while 30% would approach private equity investment. Debt markets received support from 29% of respondents, while asset-based lending (14%), wealthy private investors operating through so-called 'family offices' (3%) and the public markets (1%) scored far lower.
A separate question on the least attractive financing methods for our respondents revealed broadly similar results. Respondents overwhelmingly rejected the prospect of an IPO or use of the public markets to obtain finance, with only asset-based finance and debt markets generating any significant disinterest.
The fact that investors are now less likely to use debt and much more likely to tap into existing cash reserves reflects a more cautious approach to finance that has emerged over the last 18 to 24 months of oil price volatility. Rather than being surprising, this is just reflective of the prudent and cautions approach that people are now taking to running their businesses.
The view from the banks
Even before the oil price collapse, the regulatory regime imposed on the banks following the financial crisis had made it more challenging to lend to the capital-intensive oil and gas sector. The Basel III capital standards forced banks to introduce tighter lending conditions, reducing their appetite for investment in areas considered more risky. While large, international oil producers' access to credit is significant, lending was already becoming tougher to secure for smaller and medium-sized exploration and production firms and the oilfield services companies that supplied them.
Most banks do not see the current price of oil – less than $30 a barrel in January 2016 – as a safe environment in which to lend: in our research, conducted when the price was closer to $60-$70, seven in 10 banks said that they would not feel comfortable lending. However, this is not to say that the banks are withdrawing from the market altogether: some are keen to capitalise on the valuation opportunities that lower prices are creating, while investment bank Piper Jaffray's $139 million purchase of boutique energy bank Simmons & Co in November 2015 is one example of how banks are positioning themselves to take advantage of the predicted upswing in M&A.
Bank lending to the upstream oil and gas sector is based on regular assessments of proven reserves, known as redeterminations. As the oil price has fallen, these calculations have produced ever-lower results and banks have reined in their lending accordingly. This has had a knock-on effect to the oil services companies and in response, oil services companies can cut spending, restructure or negotiate extensions with their lenders.
While the banks that we surveyed were predominantly focused on larger transactions with bigger companies, with 40% of respondents favouring deals worth $200m or more, there are some exceptions. One bank managing director told us that small deals provided more scope to realign business activity and get it to higher performing levels. Certain geographies will also be more popular with banks with the US and Canada, where production continues and the banking sector has greater reach, continuing to lead growth.
Beyond the banks
However, smaller oilfield services companies engaged in lower value M&A transactions or seeking capital for other reasons are, for the most part, likely to find banks less willing to lend. This will require many firms to be more imaginative about their financing. Discussions with lenders about the restructuring of debt obligations will need to be held at an early stage and firms may have to make compromises - for example, agreeing to "amend and extend" arrangements that prolong maturity periods in return for better terms for creditors.
Many will also need to look beyond the banks for funding. While cash reserves will be important to many companies, the debt markets may have to play an increasing role for those borrowers large enough to command bond investors' confidence. Private equity will also have a role to play, as investors look to take advantage of opportunities created by falling oil prices in exchange for good returns if and when the market rallies. For example, last year The Carlyle Group raised $2.5 billion for its first ever energy fund, with oilfield services companies as potential investments.
Rosalie Chadwick and David McEwing are corporate law experts at Pinsent Masons, the law firm behind Out-Law.com.
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