As roiling in the markets continued this week, The Texas Lawbook surveyed various deal lawyers and investment bankers in the state to gather their thoughts on what it portends for the industry, M&A and bankruptcies. Among their observations:
• The severe drop in commodity prices will make it difficult for already struggling oil and gas companies to generate positive returns. So many will cut capital expenditures and production and look for alternative forms of financing in a tightened market to get them through difficult times, which may last a year or more.
• Borrowing base redeterminations in the spring and beyond will be bad – and unhedged and/or debt-laden companies that aren’t able to raise capital or find a merger partner will be forced to restructure, including through Chapter 11.
• Mergers and acquisitions will be dormant until there’s some settling in the market. But then the stronger companies may begin to pick up the weaker ones with good assets and mid-sized companies could combine to take out costs, possibly using creative structuring or alternative financing techniques to get deals done.
“Pencils are down,” quipped one expert. “M&A will slow to a crawl,” said another. Some are looking for hope in different directions, but they say the oil and gas sector may well be facing “a long dark tunnel” in which hedges lose their benefit and there are more bankruptcies, more consolidations, tighter capital in already tight markets and no help from the Saudis or the Russians.
Herewith are their specific comments:
Jeff Nichols, Haynes and Boone
“We are actually expecting a lot more M&A and deals in the oil patch. Oil and gas companies have been kicking the can down the road. They are highly leveraged. But this [decline in prices] will change things a lot. They’ve had a stay of execution for a while, but that time has run out.” Nichols said the price drop “affects their ability to extend capital and leverage.”
Cliff Vrielink, Sidley Austin
“This will be rough. The OPEC/Russian price war makes it tough for even the lowest cost producer to make positive returns. Add to that the sudden and dramatic fall in commodity prices, and many producers who hedged production to address expected downside scenarios may not have the benefit of those hedges, since many hedges are structured as collars that only provide protection down to a certain price. While distress often leads to buying opportunities, capital has been scarce in the oil patch for quite a while, and this price drop will make investors even more skittish. So the long and the short of it is that the industry will be in a long, dark tunnel for a while, and while we hopefully will see light at the end of that tunnel at some point, here’s hoping it isn’t another on-coming train! It seems like the Russians and the Saudis are not interested in helping the U.S. shale industry, and without positive revenues and a dearth of available capital, a new wave of bankruptcies and restructurings seems unavoidable.”
Mark Kelly, Vinson & Elkins
“Oil prices are cyclical and we’ve seen our share of highs and lows over the years. We don’t have a crystal ball to predict how long this downturn will last, but we may see a situation similar to previous downturns, which would include short-term challenges such as liability management and financial restructurings as well as a reduction in drilling. However, energy clients are resilient and we expect them to respond to this challenge just as they have in previous down cycles, so we remain optimistic in the long term and are well positioned across the board to help our clients through this cycle.”
Andy Calder, Kirkland & Ellis
“The plunge in oil prices will obviously lead to a significant tightening on liquidity and cash flow available for operations. If the price dislocation continues at the current level it is clear that there will be additional filings. Getting ahead of the issues early will be critical to saving the balance sheets of affected companies.”
Mark Sloan, Thompson & Knight
“While the long-term effects of the coronavirus’ impact on the U.S. and global economic environment cannot be known at this time, the energy industry will see significant effects. As the coronavirus continues to make an impact, coupled with natural gas prices trading at low values, we will likely see another volatile year for already strapped oil and gas producers. The industry already experienced a sharp surge in the number of bankruptcies in 2019 and that trend will continue throughout 2020. We are seeing a structure shift in the industry with lower stock prices, U.S. energy independence, lower demand and the rise of clean energy. Companies have been looking for ways to cut overhead and slow down production to lower outstanding debt.”
Hillary Holmes, Gibson Dunn
“[The collapse in oil prices] presents opportunities and challenges. For companies with strong balance sheets, it will create opportunities for acquisitions, and for private equity firms, they will gain leverage in negotiations. But borrowing base redeterminations will be bad and some companies are asking themselves, ‘How do we survive with $30 oil?’ You’ll eventually see unexpected partnerships, either joint ventures or mergers. Companies with more scale will weather the shock better. For now, pencils are down on deals – but their files remain on managements’ desks.”
Steve Trauber, Citi
“It’s going to put a lot of pressure on oil and gas companies and a lot of them are going to go bust at this price level. Inventories will grow substantially, so it will take a year, year and a half to work through all of that. A bunch of companies are hedged through the end of the year, so they won’t cut production. Those that aren’t hedged this year, we’ll see a lot of restructurings and a lot of companies going into bankruptcy. M&A will slow down to a crawl. How can you get comfortable selling your company right now, even in a stock deal? In three to six months, we’ll see bigger guys who weren’t nearly as hurt reach in and try to buy. WPX, Concho, Diamondback and Pioneer might be targets by Chevron and Exxon and the mid-sized guys need to get together. You have to take out costs, and the best way to take out costs is to combine. But we’ll need some settling before that happens.”
Sanjiv Shah, Simmons Energy
“A prolonged downturn could help advance more consolidating transactions given larger relative impact of synergies. Equity capital markets, while significantly challenged, are not entirely closed and creative structuring and/or alternative financings like PIPEs [private investments in public equity] and converts can help still get deals done. The non-bank direct lending market remains a constructive source of capital as those investors seek attractive risk-adjusted yield. We expect to see more restructuring activity (bankruptcies and out of court) and are advising in several such situations at the moment. We have also worked on successful debt exchanges and expect to see more, whether in conjunction with M&A, restructuring or just to extend maturities.”