In March, private equity firm Ares Management provided a $350 million term loan to energy producer Clayton Williams Energy at a staggering 12.5% rate of interest. The deal, which refinances the firm’s outstanding loans, was arranged by Goldman Sachs.
Along with many others in the sector, the borrower has few options.
Banks have been forced to scale back lending in the energy sector as oil prices have dropped and they have come under regulatory pressure to reduce risk. In the US, the Office of the Comptroller of the Currency has published an updated manual for energy lending with stricter guidelines for loans tied to future oil-and-gas production.
Typically banks have provided revolving credits to energy companies. Many of those were extruded two to three years ago before the price of oil started to tumble, and now some banks are facing potential delinquencies.
Smaller banks active in the oil sector in particular are expected to fail as result of energy exposure. Many of those banks were exposed to small and mid-sized companies that borrowed heavily in the shale boom, but which now find themselves unable to make profits with the lower price of oil.
Reuters data show tens of billions of dollars in loans are expected to be downsized this spring as banks tighten their belts. It’s just at the time when energy companies are beginning to find themselves stretched.
According to a report from Goldman Sachs analysts, independent oil producers have hedged only 20% of this year’s anticipated oil production.
The price of oil was thought to have bottomed out last year, but after a dip to $26 in February it is now expected to stay around $40 for 2016. Some 51 North American oil-and-gas producers have already filed for bankruptcy since the start of 2015, according to law firm Haynes and Boone LLP. That number is expected to grow.
Andy Brogan, global oil and gas transactions leader at EY in London, says that, as yet, there have been very few distressed sales and insolvencies, but the industry is under such stress that restructurings are inevitable.
“There is a valuation gap between the sellers and the buyers right now,” says Brogan. “With oil prices remaining low, buyers’ views on assets are lower than those of the sellers. But we are likely to start seeing some forced sales of assets, or transactions coming in lower than sellers would prefer.”
In the case of Clayton Williams, its loan from Ares has interest rates that are triple that collected by banks. Not only that, but Ares has the rights to buy up to 18.5 % of outstanding Clayton shares and can appoint two directors to Clayton’s board. The deal would also give Ares control over Clayton’s assets if it should fall into bankruptcy.
Much like in 2008, Brogan expects private equity to take a prominent role in the restructuring process for oil and gas firms in the next few years. “They have teams looking at this sector and money to spend. It’s just a case of bridging the value gap,” he says.
According to industry participants, there is $85 billion in private equity capital to be put to work.
Not all investors are keen to provide private equity with yet more capital, however.
Tom Carr, head of real asset products at private equity research firm Preqin, says that many end investors seem to be waiting before making commitments. “The energy fundraising market has seen a lot of activity in recent years, raising in excess of $50 billion in each year 2013 to 2015. However, as commodity prices have fallen and global markets have experienced increased volatility over the past few months, investors [are now waiting].”
As such, so far this year only six funds have closed, raising $10.5 billion, and only two funds specifically oil and gas have reached final closes, he points out. “2016 looks set to be a year characterized by competition for investor capital, as the number of funds seeking commitments outstrips the supply of fresh inflows.”
Investing in the oil and gas sector has not been the smoothest ride for private equity firms. KKR, Riverstone, and Apollo have all taken a hit on their energy investments. Last month EIG Global Energy Partners became the latest oil and gas-focused firm to report losses when it marked down the value of its 2007-vintage fund.
“It’s true that some private equity firms have experienced losses,” says Brogan, “but a lot of that pain was concentrated in funds that were latecomers or that were generalists. They were buying at the top of the cycle in 2012 and 2013.”
Brogan says there are still hot areas in energy: midstream investments such as pipelines and storage infrastructure have been popular for yield. In the last 12 to 18 months, as interest rates have remained low, Brogan says infrastructure funds have been attracted to the sector – particularly European infrastructure funds.
“It’s the upstream assets that are not moving,” says Brogan. “The closer to the oil and gas it gets, the harder it is to make a determination of value right now though.”