Insights

For independent oil and gas companies looking to finance their operations, one lending option is reserve-based lending (RBL), in which the loan amount depends on the value of their oil and gas reserves. Unlike other underwriting processes, the company’s cash flow is not what determines the amount that is available to borrow. Instead, the value of the reserves—referred to as the “borrowing base”—is what decides the loan amount. The lender will re-evaluate the reserve value (the borrowing base) on a regular basis, typically twice a year, to ensure that the loan amount does not exceed the value of the asset.

The oil and gas industry is no stranger to market headwinds and unpredictable business cycles. However, the uncertainty of the COVID-19 pandemic and the Russian-Saudi price war have sent crude to record lows and rapidly intensified the financial hardship of many oil and gas companies. The depressed prices and lower demand forecasts have led most US producers to make deep budget cuts and will force others into bankruptcy in potentially greater numbers than what we saw in 2015. That year, 69 companies filed for bankruptcy protection. To add insult to injury for at-risk companies, lay-offs and furloughs will deprive resources allocated day-to-day functions, including maintaining assets and records.

The San Juan Basin offers many investment opportunities, as it contains the largest coal-bed methane field in the world and ranks second in total gas reserves. This spotlight provides geological facts, current activity and things to know beforehand.

Background

The first oil well in the San Juan Basin spud in 1911, and since then over 40,000 wells have been drilled. Drilling activity was steady from the 1990s until 2008. In 2007, there were over 40 active rigs. Then attention turned to the prolific Marcellus, where gas could be extracted less expensively. In the past 12 months, 135 wells were completed in the Basin. The leading players include BP America, Hilcorp Energy Company, Catamount Energy Partners, and Encana Oil & Gas. 

Due diligence is the process of investigating assets to make an informed decision about the cost, benefits and risks of acquiring or investing in such assets. As an industry leader in title diligence, Cinco evaluates mineral properties across the US and works closely with our client’s attorneys and lending partners to help them navigate the risks inherent with their deal.

While no two oil and gas due diligence evaluations are alike, there are common stages and milestones that we see in every process. This article will breakdown the typical oil and gas title due diligence process and describe how Cinco supports our clients’ success at each step.

Title due diligence in certain transactions may seem like an onerous part of the deal, causing some to speed through it and overlook critical issues. Your due diligence process is the most effective insurance policy against title busts and loss of mineral value.  However, in our experience, we have seen some big mistakes made by mineral buyers that generate big regrets down the line.

Here are four big mistakes we see made all too often:

1. Overlooking Location-Specific Risks
2. Not Getting the Executive Rights or Other Rights to Lease
3. Acquiring Partial Rights Only
4. Skimping on the Diligence

Negotiating and executing oil and gas transactions are never simple endeavors. Transactions require careful analysis and decision-making on a range of issues to ensure you are making a deal that satisfies your objectives.

It is not always feasible to gather internal resources to support the oil and gas acquisition or divestiture process, particularly around title due diligence. Most deal terms provide for a relatively short due diligence period, thereby requiring a dedicated group of experts to examine the assets ahead of closing. Hiring an external party to get the job done will most likely be a necessity. When that occurs, it is important to know what you don’t know.

Here are some keys to getting the most value out of your title due diligence team:

When it comes to acquiring any type of asset, it’s important to keep your eyes open across all aspects of the business—from its past performance to its future potential earnings, and everything in between. This is particularly so when evaluating oil and gas acquisitions on the heels of several declining years, during which staff was lean, bankruptcies were common and things were left undone…leading to more physical defects, as well as financial problems. Thus, the need for careful and thorough evaluations performed by qualified professionals in land and title matters.

Tips to consider

Before finalizing that offer to acquire your next O&G entity, we suggest you take the following tips into consideration.

When the stakes are high with oil and gas acquisitions—and they always are—you need a rigorous due diligence process performed by an experienced firm to avoid driving up costs or taking too much time. This specialized analytical process, when done correctly, will help uncover potential risks as well as opportunities, while also helping to prevent investment errors or miscalculations.

Smart, money-saving questions

You can’t afford not to ask certain probing questions for vetting purposes when deciding who to hire as your oil and gas due diligence team. You’ll be surprised by what is revealed during this “due diligence” exercise.

Here are the top five:

As oil prices remain stagnant, many companies are seeking to offload non-core assets in an effort to survive the downturn. As a potential buyer, there are increasing opportunities to acquire portfolio assets at a discount. In this pricing environment, there are additional considerations any would-be buyer should plan for as part of its acquisition model.

UNDERSTANDING LIEN PRIORITY
Buying from a Distressed Seller

When reviewing buying opportunities, be sure to evaluate the financial health of the seller as part of your pre-due diligence. Identify whether the potential seller may file for bankruptcy within the next two years. If you are concerned that a bankruptcy filing may be in the seller’s future, you should ensure the transaction is at arms length and would be considered fair and reasonable to an outsider who may have an interest in seller’s assets (such as a creditor). Work with legal counsel to mitigate your risk during the negotiation period. Carefully value your assets, and understand the Seller’s financial health before proceeding with a buyer’s due diligence of the assets.

On December 31st, Swift Energy became the latest E&P to file bankruptcy, becoming the 41st company to do so since oil prices began declining in 2014. Swift Energy joins several other companies to file for bankruptcy protection in 2015, including New Gulf Resources, Magnum Hunter Resources, Samson Resources Corporation, Sabine Oil and Gas, Milagro Oil & Gas and Quicksilver Resources. Due to the continued decline in oil and gas prices, we anticipate a continued rise in bankruptcy filings in 2016.