Following up on last week's article on companies bracing for bankruptcies within the oil and gas industry, OE's Managing Editor Audrey Leon spoke with Charles Kelley and Robert Gray, Houston-based attorneys with law firm Mayer Brown to discuss the downturn in oil prices, how it is affecting the offshore industry, and what companies can do to weather the downturn before they need to file for bankruptcy protections.
OE: Given the downturn is likely to harshly affect companies whose finances were not great to begin with, what are some options for companies before they need to file for bankruptcy protection (if they're not quite there yet)?
Charles Kelley: Limited liquidity is the main problem. For those companies already suffering prior to the drop in commodity prices, their liquidity became further strained. The task for those companies is how to survive on even less. For most of those companies, the harsh reality is they may need to sell assets, monetize them, to obtain much needed funding. I assume raising further debt for these companies is not an option based on your question. It's hard sometimes for oil and gas companies to part with properties before they are ready, given how much effort went into identifying and then acquiring them in the first instance. But sale of assets in the current environment means they have to have great curb appeal. With tight liquidity previously, these companies may not have been developing and maintaining these fields as they should have, thus any sale will need to include assets of value. Thus, decisions to sell should be made early, not later after further erosion of asset value. Simply entering into farm-out arrangements doesn't solve short term liquidity issues.
Robert Gray: Surprisingly perhaps, many of our clients are issuing shares of common or preferred stock in order to maintain credit ratings and reserves to weather a prolonged low-price environment. Investors are willing to invest in what they see as depressed share prices with the expectation that commodity prices will rebound and, therefore, the share prices. In addition, we're seeing upstream companies looking to sell non-core assets (e.g., gather systems and other midstream assets).
OE: Since we're an offshore-focused magazine, what service sectors are going to be negatively impacted by this downturn in prices?
Charles Kelley: The oilfield service industry in general has been the first to feel this, before even the exploration and production companies in most instances. Because of lower revenues caused by lower oil prices, most exploration and production companies have cut back on their drilling, work over and recompletion projects – less need for service companies. Rig count data confirms this. I suspect where most cutbacks have occurred is in the area of expensive operations, such as shale or offshore, where wells cost millions of dollars to complete (offshore is in the tens and hundreds of millions). More activity is going on in the traditional formations, likely completing proven undeveloped reserves (PUDs). Thus, there is limited demand for seismic, offshore rigs, and those businesses that provide support for those operations. These are the most stressed companies currently.
Robert Gray: Clearly the offshore operators have longer time-horizons for existing production and operators are taking advantage of completion and production service companies' financial straits to negotiate better rates. As offshore drilling rigs come of contract, day rates, if obtainable at all, are being cut by up to 50%-60% and, in some recent instances, we understand that operators are cancelling contracts. To make matters worse, there is a stream of newbuilds still coming on stream for the next year/year and half.
OE: What do you think is likely to happen if low prices continue into the next 2-3 years? Will we see more companies give up on deepwater and/or harsh environment exploration and production efforts?
Charles Kelley: I suspect most capital projects in the deep water – except for those necessary to hold leases – have already been put on hold. Already, deepwater is only for those of steel spirit and deep pockets. The larger oil and gas companies are the most active in deepwater. I saw in a recent WSJ article from a month or so ago that four large deep water operators – Exxon, Chevron, Shell and Conoco-Phillips, I believe – have substantially reduced their capex budgets for 2015. The combined reductions of these large four companies was something like $80 billion that is no longer in their budgets. I would have to believe a fair amount of that was tied to offshore production. That suggests highly surprised development over the next several years offshore. If prices stay down for as long as two years, many holders of onshore traditional and shale formations (companies which may be highly levered) will be selling quite a bit of their holdings. It's hard to say whether offshore producers will be replacing production from these formations onshore, but the economics add up.
Robert Gray: Having said that, deepwater/harsh environment exploration is where most of our future reserves in the world will come from outside of North America, so I don't expect to see capitulation, as much as reduction.
OE: How can the small-to-mid-sized offshore oil and gas companies protect themselves during this downturn?
Charles Kelley: If they have marginal balance sheets already, I don't think they can survive offshore.
Robert Gray: Agree, particularly if they don't take advantage of reduced production costs.
Mayer Brown previously represented Houston-based ATP Oil & Gas on its restructuring and sale, which was one of the largest Chapter 11 cases filed in 2012.
Charles Kelley focuses on civil litigation. Prior to law school, he was employed by Amoco Oil Co. as a mechanical engineer and held positions as a project engineer, inspection engineer, and unit maintenance engineer in Amoco's largest and most complex refinery.
Robert Gray is a partner in Mayer Brown’s Houston office and is co-leader of the firm’s Corporate & Securities practice.