Just a few years ago, when oil sold for about $100 a barrel, banks here were lining up to give international oil explorers access to billions of dollars to finance new drilling and projects.
But as oil prices stay mired in a funk, the money is drying up.
Senior executives from companies such as Tullow Oil TUWOY -2.91 % PLC and Cairn Energy CRNCY -1.03 % PLC have been meeting with their bankers for a biannual review of the loans that allow them to keep drilling and building out projects. For many European companies, it has been a nail-biting experience, as banks worry about the growing pile of debt taken on by oil companies with little or no profits. Several companies said they expect their ability to tap credit lines to be diminished after the reviews.
Some lenders have brought in teams that specialize in corporate restructuring to scrutinize companies’ balance sheets, spending and assets, though not at Tullow or Cairn, a person familiar with the matter said. In the past, the reviews were generally conducted solely by banks’ energy specialists.
The new scrutiny in Europe comes as oil-company debt emerges as an issue across the world with prices for crude near $40 a barrel—down more than 60% from June 2014. Globally, the net debt of publicly listed oil and gas companies has nearly tripled over the past decade to $549 billion in 2015, excluding state-owned oil companies, according to Wood Mackenzie, the energy consultancy.
Reviews of these loans have high stakes. If a bank decides a company has already borrowed more than it can afford, the reviews could trigger a repayment, more cost cuts or even a fire sale of assets to raise cash.
Many of the reviews have concluded, or will soon, and the results could be known as soon as this week.
“There isn’t anyone in the oil independent sector that will be very relaxed at the moment,” said Thomas Bethel, a partner specializing in energy finance at Herbert Smith Freehills LLP.
Oil companies are facing a similar set of biannual reviews in the U.S., where many small and midsize companies borrowed heavily to expand during the shale boom. The number of energy loans deemed in danger of default is on course to breach 50% at several major U.S. banks, The Wall Street Journal reported last week.
But some American firms have been able to raise cash by issuing new stock or selling new debt, while in recent years Europe-based explorers have come to rely more on bank lending as investors that once pumped up the industry are fleeing in droves.
In Europe, the focus is on a specialized type of borrowing known as reserves-based lending that has mushroomed in recent years. Europe’s top 10 non-state-owned oil companies have taken on over $12 billion in such loans, which are particularly exposed to energy prices as they are secured against the value of a company’s petroleum reserves and future production.
At Tullow, Chief Financial Officer Ian Springett said he thinks the company could lose some ability to draw on its $3.7 billion credit line with its banks. Cairn expects its banks will allow it access to only about $335 million of the $400 million in credit that was once available.
“When oil was at $100 a barrel, debt was easy to get,” Cairn Chief Executive Simon Thomson said in an interview. “What we’re seeing today is a number of people suffering the hangover of having secured that debt and now possibly having trouble servicing it.”
The stakes were underscored in February when First Oil Expro, a subsidiary of the largest privately owned U.K. North Sea oil producer, called in the administrators—a process similar to filing for chapter 11 bankruptcy in the U.S. First Oil Expro was unable to meet its share of costs on one big development and was unable to keep up payments on loans in excess of $150 million.
“The key issue around First Oil Expro’s demise was the sharp fall in the oil price which led to a significant loss of confidence in the sector,” said Jim Tucker, joint administrator of First Oil Expro and restructuring partner at KPMG.
The oil-company debt reviews come at a tough time for oil explorers that aren’t brand names but take risks to open up fields in risky regions that bigger companies such as Exxon Mobil Corp. XOM 0.37 % often tap into later, such as Kurdistan in Iraq.
Investors pulled back from these companies as oil prices fell, sending share prices into the basement. That crimped their ability to raise cash by issuing new stock or selling new debt, such as corporate bonds, analysts say. The explorers’ revenues also fell, and many had to cut the value of their fields and reserves.
Some factors are working in the energy companies’ favor. Banks have an incentive not to turn the screws too tightly on oil companies, forcing them out of business and into default on loans. Several companies also have oil and gas fields that are set to begin production soon and provide a jolt of cash.
At Tullow, Mr. Springett said the company was on firm ground because a large oil field in Ghana is due to begin pumping later this year. And Cairn is developing fields in the U.K. North Sea that are due to come onstream next year, Mr. Thomson said.
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Unplanned crude oil production outages for the Organization of the Petroleum Exporting Countries (OPEC) averaged 2.5 million barrels per day (b/d) in the first half of 2019, the highest six-month average since the end of 2015. EIA estimates that in June, Iran alone accounted for more than 60% (1.7 million b/d) of all OPEC unplanned outages.
EIA differentiates among declines in production resulting from unplanned production outages, permanent losses of production capacity, and voluntary production cutbacks for OPEC members. Only the first of those categories is included in the historical unplanned production outage estimates that EIA publishes in its monthly Short-Term Energy Outlook (STEO).
Unplanned production outages include, but are not limited to, sanctions, armed conflicts, political disputes, labor actions, natural disasters, and unplanned maintenance. Unplanned outages can be short-lived or last for a number of years, but as long as the production capacity is not lost, EIA tracks these disruptions as outages rather than lost capacity.
Loss of production capacity includes natural capacity declines and declines resulting from irreparable damage that are unlikely to return within one year. This lost capacity cannot contribute to global supply without significant investment and lead time.
Voluntary cutbacks are associated with OPEC production agreements and only apply to OPEC members. Voluntary cutbacks count toward the country’s spare capacity but are not counted as unplanned production outages.
EIA defines spare crude oil production capacity—which only applies to OPEC members adhering to OPEC production agreements—as potential oil production that could be brought online within 30 days and sustained for at least 90 days, consistent with sound business practices. EIA does not include unplanned crude oil production outages in its assessment of spare production capacity.
As an example, EIA considers Iranian production declines that result from U.S. sanctions to be unplanned production outages, making Iran a significant contributor to the total OPEC unplanned crude oil production outages. During the fourth quarter of 2015, before the Joint Comprehensive Plan of Action became effective in January 2016, EIA estimated that an average 800,000 b/d of Iranian production was disrupted. In the first quarter of 2019, the first full quarter since U.S. sanctions on Iran were re-imposed in November 2018, Iranian disruptions averaged 1.2 million b/d.
Another long-term contributor to EIA’s estimate of OPEC unplanned crude oil production outages is the Partitioned Neutral Zone (PNZ) between Kuwait and Saudi Arabia. Production halted there in 2014 because of a political dispute between the two countries. EIA attributes half of the PNZ’s estimated 500,000 b/d production capacity to each country.
In the July 2019 STEO, EIA only considered about 100,000 b/d of Venezuela’s 130,000 b/d production decline from January to February as an unplanned crude oil production outage. After a series of ongoing nationwide power outages in Venezuela that began on March 7 and cut electricity to the country's oil-producing areas, EIA estimates that PdVSA, Venezuela’s national oil company, could not restart the disrupted production because of deteriorating infrastructure, and the previously disrupted 100,000 b/d became lost capacity.
The UK has just designated the Persian Gulf as a level 3 risk for its ships – the highest level possible threat for British vessel traffic – as the confrontation between Iran with the US and its allies escalated. The strategically-important bit of water - and in particular the narrow Strait of Hormuz – is boiling over, and it seems as if full-blown military confrontation is inevitable.
The risk assessment comes as the British warship HMS Montrose had to escort the BP oil tanker British Heritage out of the Persian Gulf into the Indian Ocean from being blocked by Iranian vessels. The risk is particularly acute as Iran is spoiling for a fight after the Royal Marines seized the Iranian crude supertanker Grace-1 in Gibraltar on suspicions that it was violating sanctions by sending crude to war-torn Syria. Tensions over the Gibraltar seizure kept the British Heritage tanker in ‘safe’ Saudi Arabian waters for almost a week after making a U-turn from the Basrah oil terminal in Iraq on fears of Iranian reprisals, until the HMW Montrose came to its rescue. Iran’s Revolutionary Guard Corps have warned of further ‘reciprocation’ even as it denied the British Heritage incident ever occurred.
This is just the latest in a series of events around Iran that is rattling the oil world. Since the waivers on exports of Iranian crude by the USA expired in early May, there were four sabotage attacks on oil tankers in the region and two additional attacks in June, all near the major bunkering hub of Fujairah. Increased US military presence resulted in Iran downing an American drone, which almost led to a full-blown conflict were it not for a last-minute U-turn by President Donald Trump. Reports suggest that Iran’s Revolutionary Guard Corps have moved military equipment to its southern coast surrounding the narrow Strait of Hormuz, which is 39km at its narrowest. Up to a third of all seaborne petroleum trade passes through this chokepoint and while Iran would most likely overrun by US-led forces eventually if war breaks out, it could cause a major amount of damage in a little amount of time.
The risk has already driven up oil prices. While a risk premium has already been applied to current oil prices, some analysts are suggesting that further major spikes in crude oil prices could be incoming if Iran manages to close the Strait of Hormuz for an extended period of time. While international crude oil stocks will buffer any short-term impediment, if the Strait is closed for more than two weeks, crude oil prices could jump above US$100/b. If the Strait is closed for an extended period of time – and if the world has run down on its spare crude capacity – then prices could jump as high as US$325/b, according to a study conducted by the King Abdullah Petroleum Studies and Research Centre in Riyadh. This hasn’t happened yet, but the impact is already being felt beyond crude prices: insurance premiums for ships sailing to and fro the Persian Gulf rose tenfold in June, while the insurance-advice group Joint War Committee has designated the waters as a ‘Listed Area’, the highest risk classification on the scale. VLCC rates for trips in the Persian Gulf have also slipped, with traders cagey about sending ships into the potential conflict zone.
This will continue, as there is no end-game in sight for the Iranian issue. With the USA vague on what its eventual goals are and Iran in an aggressive mood at perceived injustice, the situation could explode in war or stay on steady heat for a longer while. Either way, this will have a major impact on the global crude markets. The boiling point has not been reached yet, but the waters of the Strait of Hormuz are certainly simmering.
The Strait of Hormuz:
Headline crude prices for the week beginning 8 July 2019 – Brent: US$64/b; WTI: US$57/b
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