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January 2016 Exclusive Story

Industry Economic Health

U.S. Independents Maintaining Liquidity

HOUSTON–While high-growth business models of the U.S. independents are being tested by low oil prices and tougher access to capital, two Wood Mackenzie reports examining the financial health of the top 26 U.S. independents conclude that the larger producers–which, along with the majors, account for the majority of upstream investment and production–have the required flexibility to tide them through the near term at the very least.

Fraser McKay, corporate analysis research director for Wood Mackenzie, explains, “Most companies in the peer group have rising absolute debt levels. But at least two thirds of lower-48 production is attributable to companies with no reserves-based-lending exposure, or that have no redeterminations until 2016.”

Of those larger producers that did face fall debt redeterminations, Wood Mackenzie estimates most can accommodate a borrowing-base cut of more than 50 percent before their situation becomes critical.

McKay adds, “We anticipate discomfort in the coming months and expect more companies inevitably will fail. However, most of these companies will be small, with pre-existing structural portfolio issues. Even in the worst case scenario, the assets of these companies will be salvaged through restructuring or asset sales. But the strategic actions and cash flow neutrality goals of the largest producers in the sector will have a far greater impact on capital spend and therefore supply.”

However, concerns regarding the roll-off of hedging protection are warranted, McKay allows. For the top 26 independents, she says Wood Mackenzie estimates cash flow from hedging will fall from $9.1 billion in 2015 to $2.2 billion in 2016. “The most financially-stretched operators may be forced to enter into unattractive hedges, just to guarantee debt repayment and satisfy lender conditions,” she comments.

In a second analysis, Wood Mackenzie concludes that far fewer companies will struggle with liquidity after the October borrowing base redeterminations, contrary to speculation.

Thomas Rinaldi, institutional investor service director at Wood Mackenzie, says, “The upshot is that nearly all operators we looked at have sufficient liquidity to absorb the anticipated decline in their borrowing bases. That said, as we look forward the next 12 months, closer to one-third of these companies will need to adjust their activity levels and capital structure, or make asset sales–this assuming no change in the price deck applied by lenders. The handful of high yield operators without the required liquidity to make it through the next 12 months account for an insignificant amount of production.”

Rinaldi continues, “Although development drilling consumes cash, few consider the added liquidity provided by the added production that results. Banks basically lend on the net present value of production, so even if development-well break-evens are below the bank price deck, the capital expenditure is partially offset by a larger base from which to borrow. When we take that added production and the related increase to the borrowing base into consideration, the time to liquidity crisis for many becomes much more manageable for most.”

In conclusion, Wood Mackenzie says current conditions will not be the end of the road for the U.S. unconventional sector, and that it expects most U.S. independents–even many high-yield operators–to live to fight another day.

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