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Canadian Association of Petroleum Landmen (CAPL)CAPL Conference 2009 31st Annual Conference and General Meeting
Negotiating the Road Ahead – Banking & The Energy Sector
September 30, 2009
Bruce E. EdgelowVice President, Energy Group
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Outline
• ATB Corporate Financial Services• Industry Check-up:
– Commodity Prices– Natural Gas – Drilling / Completions– Land – M&A Activity– Upstream Equity Markets– Leverage Results– Cost of Capital
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Outline (continued)
• Lending Best Practice– Commitment (size of market)– Due Diligence / Analysis– Portfolio Management– Security – Covenants– Monitoring– Advisory Role
• What Can Go Wrong?• What the Future Holds
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ATB Corporate Financial ServicesEnergy Group
• Industry specialization with a focus on Exploration & Production (E&P), Midstream, Drilling & Services, Pipelines and Utilities
• Authorized loan book of $4.1 Billion (~ 240 borrowers)• Deposits under management over $1.7 Billion • (~ 450 deposit clients)• Staff of 30 professionals, including relationship managers,
account managers, derivatives traders and engineering• Participation in 80 syndications• Hold limits range from $15MM (B equivalent rating – S&P) to
over $100MM (A rating)
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Industry Check-upCommodity Prices - Crude
Source: Energy Information Administration
2010 WTI forecasts range from $70-$80
As of September 25
2008 average: $99.65
2009 YTD: $56.30
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Industry Check-upCommodity Prices - Crude
As of September 25
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Industry Check-upCommodity Prices – Natural Gas
Source: Canadian Association of Petroleum Producers
2010 Average AECO forecasts range from $4.00 – $6.00.
As of September 25
2008 average: $8.12/mcf
YTD Price: $4.10/mcf
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Industry Check-upCommodity Prices – Natural Gas
As of September 25
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Industry Check-upNatural Gas – U.S. Production
Source: Energy Information Administration
Shale gas production has contributed to increased total U.S. supply from 51 BCF/D to 56 BCF/D beginning in 2007
Demand is down 5% year over year as a result of the U.S. recession
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Industry Check-upUS Natural Gas Storage
Source: Energy Information Administration
Current Stock: 3,525 BCF
Last Year: 3,016 BCF
5 Year Average: 3,040 BCF
As of September 18
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Industry Check-upNatural Gas Correction – a matter of time
Source: Canoils Database, Energy Information Administration
• Massive decrease in capital spending 190 Canadian E&P Companies spent $14 Billion in
exploration and development in the first 6 months of 2009 versus $46 Billion in 2008
• Number of wells drilled / completed will not replace the production lost to decline The estimated average decline for gas is 35% annually.
The prolific shale zones is 40 – 60% in the first year• Offset by weaker demand, down ~ 2.5 BCF / day (5%) year
over year
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Industry Check-upDrilling Activity
Source: CAODC
2009 Q1 drilling utilization was the lowest since 1992
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Industry Check-upDrilling Activity
Source: CAODC, Baker Hughes
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Industry Check-upCompletion Activity
Source: CAODC
Average over period: 19,200 wells Industry analysts
expect 2009 drilling activity to decline a third year in a row.
Industry Check-upLand
15Source: AB Dept of Energy, B.C Ministry of Energy, Mines and Petroleum Resources, Saskatchewan Energy and Resources
2008
B.C. $2,662
SK $1,119
2009
B.C. $322
SK $51
Industry Check-upM&A Activity
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Suncor-Petro Canada merger valued at approximately $26.0 Billion in Q1 2009.
Source: ATB Financial
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Industry Check-upM&A Activity
Source: ATB Financial
Weighted average price: $17.72
There is approximately 37,000 BOE/D currently for sale or under review in the market according to Sayer Energy Advisors.
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Industry Check-upM&A Activity
Source: ATB Financial
Weighted average price: $64,657
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Industry Check-upUpstream Equity Market
Source: Sayer Energy Advisors / ARC Financial
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Industry Check-upLeverage Results – E&P
Industry leverage has worsened given the sharp drop in commodity prices.
Data Source: Canoils Database
WTI Price
Most leveraged:
< 1,000 BOE/D
Leverage: 44.0x
Best positioned:
> 20,000 BOED
Leverage: 1.7x
Mid Cap:
1,000 - 20,000 BOED
Leverage: 3.9x
Industry Check-upCost of Capital
• Interest rates are at all time lows• Despite significant increases in spreads (premium over
base rate), borrower’s cost is still very reasonable• Issuing equity may be necessary for survival but at
depressed valuations it can be dilutive to shareholders• Mezzanine / Bridge financing is still available, albeit on a
selective basis and at a much higher cost• Borrowing bases have been tested due to lower price
deck, lack of reserve growth and reserve write-downs / reclassification
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Industry Check-upCost of Capital
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Recently priced investment grade deals (BA spread in bps)
• Although spreads have increased significantly, the BA base rate has fallen from an average of 3.04% in 2008 to 0.58% in 2009
• In the single hold market, Prime spreads have increased from 0.25% - 1.00% to 1.25% - 2.00% (depending on credit quality)
• Prime base rate has also fallen from an average of 4.73% in 2008 to 2.54% in 2009
• Bank of Canada has signalled they will keep rates at the current level for at least one year. However, the changing F/X environment may impact the Bank’s decision
Average BA Spreads OLD NEW % changeA- or Higher 30.0 237.5 692%BBB+ 45.0 262.5 483%BBB 57.5 283.3 393%BBB- 71.3 325.0 356%< BBB- 92.5 375.0 305%
Lending Best PracticeCommitment
• The Energy Lending Business in Canada has grown from $16 Billion in 2005 to $31 Billion in 2008
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Bank Debt is a key source of capital to the oil and gas industry
Lending Best PracticeDue Diligence
• Counterparty analysis is required to establish a risk rating, which impacts: – Portfolio limits (How much can we lend to a sector?)– Hold limits (How much can we lend to a customer?)– Pricing / Fees (How much do we need to charge to make the sector
threshold return?)• For E&P, we specifically focus on:
– Operating costs / break even costs– Reserve replacement– Finding & Development Cost– Recycle Ratio– Funding Check
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Lending Best PracticePortfolio Management
• General factors always considered, regardless of industry:– Management and Directors– Balance Sheet Composition– Asset Quality
• Overall portfolio limits are in place to ensure banks are not overexposed to any particular sector and managed by:– Default insurance / Credit Default Swaps: banks can purchase
insurance to protect against potential losses due to default• Smaller corporate entities – forward view (reserves / prices)• Larger corporate clients – Unsecured, for E&P at 50,000 BOE/D.
Historical perspective (prior period debt and cash flow)
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Lending Best PracticeSecurity
• Security provides lender with a legal means of recovering a loan in the event a borrower defaults on its debt obligations and a realization scenario follows formal demand
• Small to midsize loans secured by company assets, general security agreement, or fixed/floating charge debenture
• Larger corporate clients – Unsecured, typically rated externally by a third party (e.g. S&P or Moody’s). Historical perspective (prior period debt and cash flow)
• For E&P, a Borrowing Base is determined from the Company’s reserves and is the major component of a bank’s security
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How Reserves Are Like Fish
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• Proved Developed - The fish is in your boat. You have weighed him. You can smell him and you will eat him
• Proved Undeveloped - The fish is on your hook, in the water, by the boat and you are ready to net him. You can tell how big he is (They always look bigger in the water)
• Probable - There are fish in the lake. You may have caught some yesterday. You may even be able to see them but you have not caught any today
How Reserves Are Like Fish
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• Possible - There is water in the lake. Someone may have told you there are fish in the lake. You have your boat on the trailer but you may go play golf instead
• Divested - You used to have a fish, but you traded it for magic beans. You also used to have cash flow, infrastructure and a job in exploration. Now all you have is beans
Technical Reserve Definitions
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Lending Best PracticeCovenants
• General covenants impose restrictions - for example, a negative pledge prevents granting security to another party
• Covenants are tighter for smaller, higher risk borrowers:– Borrowing Base Test, Working Capital
• Large Corporate: – Debt to Cash Flow, Debt to Capitalization
• Financial ratio covenants outline lenders expectation of financial health on a “going concern” basis
• Early warning signals often get created to monitor performance based on forecasts and budgets and allow both Lender and Borrower to monitor progress prior to triggering formal default
• Pricing grid mechanics can tie into covenant threshold
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Lending Best PracticeMonitoring
• Borrowers have to comply with certain reporting requirements including:– Annual reserve report (third party prepared in most
cases)– Annual and quarterly financial statements– Compliance Certificate– Monthly production reports– Annual cash flow budget
• Financial covenants are followed to ensure the Borrower is a going concern
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Lending Best PracticeAdvisory Role
• Lenders’ broad view of the market can assist Borrowers with:– Understanding market changes in lending policy or
credit availability– What borrowing rates are in the single hold versus
syndicated market– Who is actively buying / selling assets or interested in
merging– What other forms of capital are available, such as sub
debt, equity, convertible debentures
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What Can Go Wrong?
Portfolio Rebalancing• A Bank’s sector and industry limits are subject to change.• Negative external events in a sector (for example, weak
commodity prices) can reduce the amount of capital available.
• Exposures are reduced by one of the following strategies:– Borrowing Bases are “low balled”– Borrower requests are delayed or ignored– Borrowers are de-marketed directly through non-renewal
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What Can Go Wrong?
Client Exposure• During robust times in the market there is a tendency
towards relaxing lending best practices:– Stretch financing– Loose terms, no financial covenants– A bet on Management
• It takes the income from many “good” loans to replace losses from 1 or 2 “bad” loans
• Over $300MM in drawn loans would be required at today’s rates and fees to replace a $10MM loss
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What Can Go Wrong?
Troubles in Head Office• There is an abundance of capital when times are good• Negative events in head office impact the ability of local
Lenders to participate in deals and limit local management practices
• Foreign Banks: problems in the home country can cause international offices to contract
• Borrowers must be aware of the concentration of foreign banks in their syndicate
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What Can Go Wrong?
Working Capital• Poor working capital management is the biggest cause of
company defaults• High debt utilization (inclusive of working capital) leaves
little or no margin for error if:– Cash flow is lower due to a drop in commodity prices or
production is offline (plant turnaround)– Borrowing Base is reduced due to poor reserve replacement or
low price deck• At ATB we require Borrowers to maintain a 1:1 adjusted
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What Can Go Wrong?
Management Issues• Lack of formal due diligence on asset or corporate
purchases prior to completion (financial versus operational focus)
• Management Entrenchment:– Inability to sell assets or transact – Building estate – Personal concern with respect to re-starting or obtaining
employment– Discord among Managers, Board Members and Major
Shareholders
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What Can Go Wrong?
Reporting / Communication• Late reports (financial compliance, production, etc).• Poor quality reports • Phone calls or e-mails not returned.• Relevant information not disclosed.• Lender discovers problem, is not advised by Borrower.
Absence of trust means relationship is breaking down!
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What Does The Future Hold?
• Gas focused producers, especially small juniors, will struggle to survive if gas prices do not recover this winter
• Consolidation of smaller players needs to continue• Management entrenchment is still an issue• Optimism in the market due to the very recent oil price
recovery and resurgence of a few mega oil sands projects• Equity market opening up ($5.4 Billion year to date)• Reverse takeovers by successful management teams.• Business combinations on a share deal basis and asset
purchases funded by equity
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What Does The Future Hold?
• Rationalization of expenses (Operating and Capital)• Ongoing Borrower / Lender due diligence – who is left, at what level
can deals still be done (bank holds), who can join syndicate• Need to protect balance sheet when stretching to grow –
derivatives / equity / sub debt / form of vendor take back• Should last quarter of 2009 not see a rebound in gas prices, 2010
borrowing base reviews could be more challenging than this year– Lack of reserve replacement– Diminished value of reserves in place– Fully drawn bank lines / lack of capital– Pressure on working capital
• Lending community resolves to support this industry through tough times
