public companies reported a reduction in their borrowing base.
Of those 44, 21 had reductions of at least 30% (based on information
from a July 2016 article by Haynes and Boone LLP, 2016 Spring Oil
and Gas Borrowing Base Redetermination: The Day of Reckoning,
that ran in Practical Law Finance). Again, these are public companies generally with diversity of production and potential access
to the equity markets. One can only imagine the number of smaller
private companies who were affected.
As to the banks having been overly lenient and “the math
doesn’t work” given the significant decline in oil prices, I agree
that on the surface it might seem odd. However, it’s not that simple.
Banks can’t be robotic by relying on math only to govern credit
decisions. Lenders take several factors into account such as whether borrowers could issue equity or sell assets. Understanding that
these actions take time to implement, banks selectively granted
extensions to borrowing base determinations to some producers.
In exchange, lenders received the benefits of anti-hoarding provisions, mortgages on additional properties and the establishment
of deposit account control agreements (DACAs). For lenders,
these protections might not have been available (or at least delayed)
if the borrower was pushed into bankruptcy.
There is an assertion that the rules were changed to avoid large
losses. Even if that was true, it didn’t work for the period 2015 –
early 2016 as three large energy banks took a $3.5 billion reserve
against potential oil and gas loan losses (again, based on information from the aforementioned July 2016 article by Haynes and
When a bank establishes loan loss reserves, scrutiny of questionable loans is maddeningly detailed and subject to many layers
of internal as well as external review from regulators. I can’t imagine
a bank being so naïve as to suddenly change the rules and think
it will go unnoticed. In fairness, the OCC has implemented new
rules that can affect how lenders set borrowing bases, but it was
not the result of banks changing the rules.
As to whether changing the rules created artificial market
dynamics and prevented companies from distress or bankruptcy,
the facts show a different story. According to the Haynes and
Boone LLP Oil Patch Bankruptcy Monitor from December 2016,
in 2015 and 2016, 144 North American oil and gas companies filed
Considering the number of bankruptcies and the number of
companies experiencing borrowing base reductions, market dynamics were certainly affected despite the action, or, inaction of
The article cited numerous examples as to how the rules were
changed, but in my opinion, few of the actions would move the
needle substantially (if at all) to “prop-up” a borrowing base. In
my opinion, these changes could not materially increase a borrowing base. Here, the examples in question.
INCREASING PDP RESERVES THROUGH LOWER DECLINE
RATES AND LONGER WELL LIVES
Unless the total remaining EUR is increased, lower decline rates
generally do not result in a higher PV of PDP reserves. Think about
it—the math doesn’t work. There is one exception to this with
recently drilled wells but it seldom happens and the explanation
is not worth the detailed discussion.
ADDING OTHER PUDS THROUGH VARIOUS MEANS
Changes to PUD values often do not translate into increases in
borrowing bases. Many borrowing base calculations are already
constrained as non-PDP reserves cannot account for more than
20-30% of the total. For example, if a producer has a $100 million
borrowing base but is already constrained, their non-PDP reserves
can increase from $80 million to $200 million, but in isolation
would contribute little additional value in a borrowing base
BANKS LOWERED D&C COSTS, OPERATING EXPENSES
Banks are supposed to lower these costs if they have gone down.
A reduction in operating expenses is accretive to a borrowing
base, but would have to be evidenced in Lease Operating Statements, or, proven reductions in future costs. A decline in D&C
will affect PUD value, but is irrelevant if the borrower is already
ADDING MORE WELLS TO THE COLLATERAL (ALTHOUGH
MANY COMPANIES WERE AT 80% OR MORE IN 2014)
This doesn’t increase the borrowing base since the reserves were
already accounted for in prior borrowing base calculations. It
merely improves the banks collateral position by mortgaging more
No doubt, in the early part of the decade, banks started relaxing
lending standards to remain competitive. But there is no set of
rules to protect a bank from the dramatic drop we’ve seen in oil
prices. Once the bottom fell out, new rules of engagement had to
be created since banks had very little experience in handling
problem RBLs. Banks likely made some mistakes in restructurings,
especially in the early stages in 2015 and early 2016. Despite taking
some lumps in navigating through an industry restructuring,
banks did not conduct “shell games.” It’s simply not in their DNA.
When you add in the regulatory oversight suddenly thrust onto
the industry, the risk of being caught playing “shell games” was
never an option.
ABOUT THE AUTHOR
Larry Derrett is an energy finance consultant based
in Houston, TX. He has over 30 years of experience
in the upstream, midstream, oilfield services, and
trading sectors as a banker, consultant, and VP
Finance/CFO. He has served as CFO of ARM Energy,
a privately held provider of risk management and
physical marketing services to producers throughout the US,
CFO of ERG Resources LLC, and as a managing director with
CIT Energy, among other roles. Derrett holds a BBA from The
University of Texas at Austin.