Deals That Get Done When Black Gold Goes Bust

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Includes: AWK, CHK, EGC, EOX, GDP, HK, MPO, OAS, OXY, REN, REXX, SD, SN, SNMP, WMB, XCO
by: Small Cap Capital
Summary

Debt exchanges, divestitures, and other restructuring transactions are getting done amidst dearth of M&A activity in oil and gas.

Surprisingly not too many sizable bankruptcies in spite of dozens of names in technical default.

Creative structures and deals are getting crafted, but what is the endgame?

With the steep decline of crude oil price that continues on a sustained basis, many E&P stocks have gotten decimated. A vast majority of small-to-mid-cap E&P companies had high leverage and negative cash flow (OCF-capex) even when oil prices were above $100/bbl. It makes a lot of sense that equity value is getting squeezed - right? What is actually intriguing is that there have not been that many bankruptcies even when dozens of companies have uneconomic acreage position (breakeven prices above today's price), low hedging position this year and essentially naked for next year, already breached multiple covenants (in technical default), limited divestiture opportunities, fixed cost (G&A + interest expense + principal repayment) far in excess of expected cash flow, market value of debt and equity pricing in expected bankruptcy for months now, and no signs of meaningful recovery in the broader supply / demand dynamic.

Senior bank debt lenders continue to waive and amend credit agreements and continue to kick the can down the road. This makes sense because quantum of senior bank debt is low relative to the asset base of the company. While new drilling is uneconomic for most players at today's price, marginal cost of production breaks even at far below $20/bbl, so there is value in proved developed producing ("PDP") reserves. You could argue that unproductive acreage at today's pricing environment is worth $0, but the truth is, acreage positions with break-even prices at $70/bbl still get transacted (albeit at substantially lower prices than a year ago) - E&P is a cyclical industry and people recognize that. You do not need everyone to agree with the price at which it clears - you just need one buyer to actually pay that amount. In short, often times, PDP alone more than covers bank debt and there is always some value assigned to PUDs, 2P, and 3P reserves. It can be a bigger hassle for the bank to take a writedown than to just keep waiving covenants and amending credit agreements.

Now, more subordinate debtholders started throwing in the towel and ownership base is changing hands. There has been a large inflow of "sophisticated" money (and "dumb" money) in oil and gas debt. These guys are not going to bend over like the banks but they are also willing to negotiate and restructure since they either have a low cost basis or have capital invested across the capital structure.

It is no surprise that there are ample restructuring activities in a struggling industry and it is not the first time it has happened in the oil and gas space. Having said that, the sheer number of independent public E&P companies and the level of leverage employed by the industry as a whole easily dwarf the number of companies and aggregate leverage during past oil price declines. This article mostly lays out some broader capital markets / restructuring themes and select transactions that are noteworthy. While one can write an in-depth article for each of these transactions, here is just a quick cliffnotes version of a list of transactions (ONLY by producers in distress) that have been executed for those that are not oil & gas bankers or distressed debt traders.

Debt Exchange:

  • Exco Resources (NYSE:XCO): Canadian financier, Prem Watsa, lent $300 million as part of $591 million loan package in secured notes. As part of this transaction, XCO exchanged $577 million of bonds for $291 million in loans (50 cents on the dollar).
  • Goodrich Petroleum (NYSEMKT:GDP): GDP announced exchange agreements whereby it will retire $158.2 million in exchange for issuance of $75MM of new second lien senior secured notes (47 cents on the dollar). Holders will collectively receive warrants to acquire 6 million shares of common stock at an exercise price of $1.00 per share.
  • Halcon Resources (NYSE:HK): HK negotiated exchange agreements with holders of unsecured debt. Agreed to issue $1 billion principal amount due 2022 in exchange for ~$1.5 billion of principal amount (66 cents on the dollar).
  • Midstates Petroleum (NYSE:MPO): MPO exchanged $630 million of its unsecured notes for new secured notes in aggregate principal amount of $504.1 million (80 cents on the dollar).
  • RAAM Global Energy (Private): Announced offer to exchange its senior notes for newly issued notes and common stock. The deal was $226.6 million of senior notes for $50 million (22 cents on the dollar) in new debt and 95% of common equity! What is notable about this is the fact that after amending and extending the offer seven times, the deal failed to be executed (even after offering to give 95% of common equity!).
  • Sandridge Energy (NYSE:SD): To date, SD bought back $350 million of bonds for $124.5 million in cash (35 cents on the dollar), exchanged another $40 million in bonds for equity, and exchanged $575 million of its bonds for new convertible bonds. In aggregate, this is $965 million of debt that has been addressed which is a meaningful position of the $3.2 billion in total debt at year end 2014.

Divestitures and other M&A:

  • Emerald Oil (NYSEMKT:EOX): Announced JV with Koch Exploration to divest 30% working interest in all of its undeveloped southern drilling spacing units in McKenzie County and leasehold in Richland County for $25 million proceeds which will be used to pay down the revolver.
  • Energy XXI (EXXI): EXXI announced sale of East Bay Field for $21 million to a private buyer in July 2015. It also announced the sale of Grand Isle Gathering System to CorEnergy Infrastructure for $245 million in cash and assumption of abandonment liabilities related to the asset in June 2015.
  • Exco Resources: XCO announced a services and investment agreement with Bluescape whereby Bluescape will purchase $10 million in XCO's common stock from XCO and additional $40 million in open market. XCO also announced sale of 25% interest in Compass Production Partners and 50% interest in Compass Production GP to Harbinger Group for $118.8 million in cash.
  • Resolute Energy (NYSE:REN): REN announced a sale of its Hillight Field assets in the PRB to a private party for $55 million (September 2015) - proceeds were used to delever. Separately, REN commenced a marketing process for its Gardendale property in Midland and Ector Counties.
  • Rex Energy (NASDAQ:REXX): REXX announced sale of Water Solutions Holdings to American Water Works (NYSE:AWK) valued at $130 million - proceeds were used to pay down revolver. It also entered into JV with ArcLight to jointly develop 32 designated wells in Butler Operated Area to lower 2015 capex program by $60 million.
  • Sandridge Energy: SD announced a deal to purchase Pinon Gathering Company from EIG for a total consideration of $126 million (October 2015). As a result of the transaction, SD will eliminate minimum volume commitment payments of about $40 million per year. SD separately announced filing of registration statement for its saltwater disposal and water gathering asset in October 2014 and subsequently received IRS blessing for MLP qualification. However, no further actions have been taken around monetization via MLP.

Other Notable Transactions:

  • Chesapeake Energy (NYSE:CHK): CHK and Williams (NYSE:WMB) agreed to expand gas gathering services in Utica in exchange for consolidating Haynesville contracts to optimize production opportunities, fee structures, and restructure commitments to incentive long-term development. This transaction is notable in that it addresses the problem of both upstream and midstream companies over-expanding in the last few years that left them with too much volume commitment across multiple gathering contracts. This streamlines a hodgepodge of contractual commitments and provides CHK with flexibility to focus on their core areas.
  • Oasis Petroleum (NYSE:OAS): OAS announced that it plans to amend unsecured notes indenture that would cap secured indebtedness. Once achieved, they would be able to incur additional secured debt and not breach covenant.
  • Occidental Petroleum (NYSE:OXY): By no means is OXY distressed (especially relative to other producers mentioned above) but in any case, OXY divested ~300,000 net drilling acres in non-core Bakken for $500 million after announcing that it is seeking to sell this acreage for as much as $3 billion in 2014 (October 2015). This equates to ~$1,650/acre! It seems like bid-ask spread is narrowing down and sellers are blinking first so perhaps this is a sign that more acreage deals will get consummated - but a depressing wake-up call for the sellers that they may have to accept 1/6 of value they assigned to their assets one year ago.
  • Sanchez Energy (NYSE:SN) and Sanchez Production Partners (SPP): Again, SN is not in as much trouble as other companies mentioned in this article. In any case, SN has been doing some creative transactions that I think are worthy of mentioning. SN sold its Western Catarina Midstream asset to SPP (its midstream MLP vehicle) for $345 million - pretty standard sale of non-core midstream asset to its MLP vehicle. But on a much more interesting note, SN executed a transaction with SPP whereby it is selling wellbore of producing oil and gas wells. The upstream partner drills a well and benefits from recouping ~60% of a well's NPV during the first two years or so. Once it reaches steady production (low decline), it drops it down to its MLP vehicle - providing stable cash flow for MLP and monetizing production for capital redeployment and capital gain for the upstream company. Over time, SN can drop down additional working interest in this pool of wells or further drop down additional wells that have reached steady state. Genius!

Bankruptcies:

* Note that most of these names are small private operators, excluding Endeavour, Quicksilver, Sabine, Samson

Endeavour International (October 2014); WBH Energy (January 2015); Quicksilver Resources (March 2015); Dune Energy (March 2015); ERG Resources (April 2015); American Eagle Energy (May 2015); Saratoga Resources (June 2015); Milagro Exploration (July 2015); Sabine Oil & Gas (July 2015); Black Elk Energy (August 2015); Samson Resources (September 2015); Miller Energy (October 2015)

Thoughts:

  • Fall 2015 borrowing base redetermination season was closely monitored by investors as to how much regulatory pressure and the new norm of sub-$50 oil price environment would reduce borrowing base of oil and gas companies. Result? So far, only 2% of total capital available under revolving credit facility has been reduced from companies that have reported.

Fuelfix.com article: Oil borrowing bases cut 2 percent so far, Jefferies says

RBN Energy article: Time of the Season - Fall Borrowing Base Redeterminations for E&P Companies subdued so far

  • What did all of these capital markets / M&A transactions do for these distressed companies? What is the endgame? None of them have emerged from 'state of distress' or have provided stability in equity value in the market. All else being equal, they have now pushed out timing of their ultimate demise. Many of these transactions are in fact dilutive and value destructive for equity in the long-term and for the ones that are positive for equity, the magnitude of uplift is far removed from the stress point from an equity holder's point of view. To me, it seems like a lot of CEO's just extended another year of salary, bonus, and access to corporate jets and are in wishful state for God to smile on them with $100 oil price. In any case, what an interesting time to be a debt investor in oil and gas.
  • Lastly, a random thought… Lift the oil export ban from the U.S. There are equally compelling arguments around how this would not impact gasoline price and refiners. Spec differences in how U.S. refineries are designed aside, it is perplexing that there is so much opposition for lifting oil export ban when U.S. still imports 4 million barrels per day (~50% of U.S. production volume) and as a sector, contributed to one of the highest growth areas in capital investment and employment. U.S. carmakers have struggled and arguably have lost their edge against foreign brands - government is not imposing exorbitant tariffs on importing BMW or Toyota like many other car manufacturing countries do. Isn't this why U.S. is a free market and is the capitol of capitalism? Isn't this why there is so much "cheating" even within OPEC and why EU was bound to not work and socialism ultimately fails? I do not know if lifting oil export ban moves oil price lower or higher - but let the producers and market figure that out. I am guessing nothing will happen for another year or so given the election coming up but thought I would throw it out there.

On a closing note, there are many more zombie E&P companies that are in deep trouble and another handful of companies that have not done much yet but have retained restructuring advisors. I suppose many more interesting and creative deals will get transacted in the near future - not just E&P companies but also MLPs.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.