Analysis

Oil Price Drop May Deliver Knockout To Shaky Energy Cos.

By Keith Goldberg
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Law360 (March 11, 2020, 7:27 PM EDT) -- The latest oil price collapse will accelerate the pace of U.S. oil and gas bankruptcies, and industry watchers say the fallout includes a bumper crop of unwanted assets that could drive many companies out of existence while producing a host of environmental and contractual headaches.

Bankruptcies in the oil patch were already on the upswing before prices plunged into the $30-a-barrel range this week amid moves by Saudi Arabia and Russia to dramatically increase their oil production, as well as plunging global demand due to coronavirus concerns.

With approximately $200 billion worth of oil and gas company debt also set to mature within the next few years, industry watchers are now bracing for a repeat of the 2016-17 flood of driller bankruptcies that followed a similar oil price crash.

But experts say the last bankruptcy wave was more about companies restructuring debt and reducing it through asset sales. This time around, financially stressed oil and gas companies find themselves in an already chilly market for transactions, with no investor help on the horizon.

"At $30 [per barrel of oil] and $1.60 [per million British thermal units of gas], there aren't a whole lot of assets in this space that make any sense at all," said Sean Clements, a restructuring partner at energy advisory firm Opportune LLP. "At this price deck, there are going to be assets that are just simply unwanted."

The latest price plunge will push more oil and gas assets into financially unattractive territory, experts say. They're expecting nastier bankruptcy cases as creditors fight over pieces of a smaller pie, as well as more potential liquidations for companies that have too many of those assets on their books.

Meanwhile, unwanted assets carry a host of problems, including plugging and abandonment liability for oil and gas wells, canceled leases and oilfield service contracts, and soured joint ventures. All of those are areas that are ripe for litigation, experts say.

"The challenge with unwanted assets is that they create multiple unknowns on the legal and regulatory fronts, given the web of relationships tied to each well," said Holland & Hart LLP bankruptcy and real estate partner Matt Ochs. "We will soon be learning a lot about how the courts, regulators, debtors and purchasers view their responsibilities, rights and options."

For starters, a bunch of unwanted assets will increase the trend of fewer prepackaged deals from the previous bankruptcy wave, while also reducing debt-for-equity swaps that highlighted out-of-court restructurings prior to that wave, experts say. Meanwhile, asset sales that may have helped plug holes in a company's balance sheet are going to be a lot more difficult to pull off.

"You're going to see more contested bankruptcies, as there's not an expectation of companies coming out alive," said Daniel Charest of Texas litigation firm Burns Charest LLP, who specializes in oil and gas litigation. "It's a yard sale, and that's a whole different kettle of fish."

Indeed, experts say there's an increased risk of companies simply disappearing because they can't find a taker for their assets.

"We may see more liquidations, and assets being sold are opportunities for people who have deep pockets and that are looking for bargains out there," Jackson Walker LLP bankruptcy partner Bruce Ruzinsky said.

Clements said those deep pockets may be limited to oil majors that can afford to scoop up drilling properties and either delay their development cycles or stop oil and gas production until prices recover to a point where they are economically viable again.

"Consolidation has to lead to production coming offline, so who's going to buy assets just to take them offline?" Clements said.

For wells that are producing oil and gas, a lack of buyers then raises the question of who shoulders the costs for plugging and abandoning those wells, especially if the operator of those wells goes belly-up. That's a massive environmental liability that state and federal regulators generally don't like leaving unaddressed, experts say.

"It will be interesting to see if jurisdictions start going down that chain of title to say, 'You owned this asset prior to the current bankrupt entity, so you are now responsible for plugging those assets,'" Clements said.

He added that that could produce legal fights similar to the one in 2013 when ATP Oil & Gas Corp. couldn't pay to decommission offshore facilities that had been purchased from Anadarko Petroleum Corp. Anadarko believed that when it sold the assets, ATP took on the decommissioning obligation, but ultimately a bankruptcy court required Anadarko to foot the bill as predecessor in interest.

"It's going to be brutal," Clements said. "How many Anadarkos are you going to find at the back of these titles? I don't know, maybe not a lot."

An indication of how big a flood of unwanted assets the latest crash produces could come this spring, as lenders redetermine the borrowing bases for reserve-based loans. Those loans, a staple of energy industry lending, are based on a company's total reserves and the price of oil, and are usually revised twice a year.

Jackson Walker partner Matt Cavenaugh, who focuses on bankruptcy litigation, said many drillers were already limping into borrowing base talks even before the one-two punch of coronavirus and Saudi Arabia and Russia ramping up production.

"This is just a real gut punch on top of what was already a very bad situation," Cavenaugh said. "In terms of the demand destruction and supply destruction, the really remarkable thing about this is the timing. It's all happening at once."

Haynes and Boone LLP conducts an industry survey in advance of each borrowing base redetermination period in order to gauge what energy companies and lenders are thinking. On Monday, when oil prices plunged toward the $30-a-barrel mark, the firm said survey respondents could resubmit their answers.

"I think there was already an expectation that most lenders were going to keep their borrowers on a pretty short leash this redetermination season," said Kraig Grahmann, who heads Haynes and Boone's energy finance practice group. "I think what you're going to see is that if there was any bit of slack left on that leash, it's now gone."

With other sources of capital or debt essentially unavailable, that's a recipe for bankruptcy, experts say.

Grahmann said it's become apparent that lenders want to see oil and gas assets not only able to produce cash at expected commodity price levels, but withstand periodic price slumps such as the current one.

"There are certainly assets out there that when you have a downturn and you're selling at a spot price, you're really losing significant amounts of money each month and it makes more sense to shut in your wells," Grahmann said. "Those types of assets, they could be this new category of unwanted assets."

--Editing by Philip Shea and Alanna Weissman.

For a reprint of this article, please contact reprints@law360.com.

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