In May, Perenco signed a $2.7 billion syndicated loan – mostly in the form of a reserves-based borrowing facility – the largest of its kind to be closed in the European market. And May also heralded a return to underwriting when Credit Agricole and Standard Bank underwrote a £250 million reserve based facility for PA Resources.

Banks not traditionally associated with the upstream sector have spotted the opportunity to form lucrative relationships – in a sector with strong fundamentals – created by the departure of other banks with weaker balance sheets.

“The investor base shrank as banks pulled back, scaled down or went away,” says William Stevens, global head of reserve-based advisory and lending at HSBC. “But for those investment banks still in the market there is a great opportunity provided they are prepared to put money on the table.”

But conditions have changed, and where once banks lent based on the value of an asset, those still lending are now watching the assets’ liquidity far more closely. Several bankers have also emphasised the importance of strong management teams, and though it remains possible for smaller independents to raise funds if they have strong projects, the climate is one of consolidation in the market, with good assets often going cheaply.

“Six or seven years ago people operated under the assumption, justified at the time, that there would be enough liquidity to finance the development of a company, whether through bank debt, bonds or equity,” says Frank Pluta, head of upstream oil and gas finance at Credit Agricole. “Now, banks are looking more deeply into liquidity. Funding and liquidity tests are now in place on all deals, and there has also been a flight to quality.”

The Oilexco bankruptcy of early 2009 epitomised the difficulties for small independents during the credit crunch, and the reason banks are now cautious.

The company had good assets, but it lacked sufficiently strong cashflow and was unlucky enough to need to refinance a $700 million borrowing base facility at a time when oil prices had crashed down to around $40 per barrel. Royal Bank of Scotland refused to refinance, and Oilexco was liquidated. Premier Oil raised a $650 million acquisition loan along with a rights issue for £171 million to buy the Canadian company, which had assets in the North Sea, working out at a price of $8.50 per barrel. Oilexco received a notional $1 for the sale.

The extent to which this represented a bargain for Premier Oil was highlighted with the announcement in June this year of a significant find in the Catcher field, in which Premier holds a 35% stake from its acquisition of Oilexco’ assets. Exploration yielded estimates of 25-50 million barrels of high quality oil, compared to pre-drilling expectations of 18-33 million barrels – rare good news for North Sea independents, where production is declining as reserves dwindle faster than they are replaced.

While Oilexco may have failed to refinance its loan, the reserve based lending market’s contraction wasn’t all due to the banks withdrawing. With oil prices plunging, companies also decided to reign in their capex plans.

“The break-even cost was talked about a lot last year,” says Jean-Luc Amos, senior oil analyst at KBC Energy Economics. “Last year was the worst for the oil industry. This year prices are at $70 to $80 and that makes a lot more sense. It is a comfortable level for upstream investment and is thought to be above the break-even level for the Saudi Arabian 2010 budget. Prices significantly higher are not particularly desirable by the Saudis as this may trigger development in renewable energy.”

Even when the spot oil prices were above $100 a barrel, more prudent banks kept price decks between $55-$60. Those fell to around $40-$45 last year, but have since returned to $55-$60. “With stable oil prices, boards are happy to give the go ahead on investment decisions,” says one banker.

As well as the improved price environment, another factor that helps the independents is that costs have fallen significantly compared to before the credit crunch – though the repercussions from the Gulf of Mexico spill will work in the opposite direction, driving costs up.

“Not only have the price of rigs, seismic vessels and drill ships come down compared to the feeding frenzy until early 2008, but suppliers also offer greater flexibility,” says Richard Lorentz, of KrisEnergy. “Typically these had to be contracted on a two-year basis, but now they are available on a spot basis.”

The turnaround in the market is reflected in a spate of financings for offshore infrastructure assets that ran into financial difficulty as a result of the credit crunch. After Premier purchased Oilexco, it decided to decommission its Shelley field. This left Sevan Marine’s Voyageur FPSO, which was meant to service the field, in the lurch and in need of a new customer. In March, Sevan restructured $300 million in debt closed in 2008 to finance Voyageur’s construction.

The restructuring of the Jubilee FPSO has also been prompted by the credit crunch, and in May Grupo R of Mexico acquired the drillship PetroRig III for $655 million after PetroMENA, the previous owner and operator, went bankrupt.

Acquisitions

Underlining the notion that now is a climate of consolidation, a major component of Perenco’s financing in May is to fund the acquisition of new assets. The loan encompasses reserves in Africa, South America and the UK, and is part of a shift in focus for the company away from declining North Sea fields.

The financing consists of a $1 billion five-year revolver with the option of increasing to $2 billion and a £500 million seven-year letter of credit to cover North Sea abandonment costs. Societe Generale, BNP Paribas and Credit Agricole are the mandated lead arrangers, while Bank of Scotland, Citibank, ING, Natixis, Standard Chartered, Bank of Tokyo-Mitsubishi and Royal Bank of Scotland have also come into the deal.

But Perenco and Tullow Oil, which has also been back in the debt markets recently, are large outfits among independents. Perenco was also helped by the fact it had funded its previous expansion without recourse to reserve based borrowing. Conditions are harder for smaller independents – given the need for diversified portfolios with solid base of producing assets – but there have been deals that prove that it is still possible for them to raise finance.

The $900 million corporate facility from RBC to Dana Petroleum, which earlier in the year had itself been subjected to takeover rumours, breaks down into a $300 million four-year term loan and a $600 million five-year revolving credit facility. It finances the purchase of Petro Canada Netherlands for Eu328 million ($393 million) and refinances an existing $400 million facility put in place last year, with Bank of Scotland arranging, that was used to finance Dana’s capex plan. The remainder funds Dana’s capex plans, and also covers the put option in 2012 on around £140 million convertible bonds.

It is the latest acquisitions for Dana, which purchased Bow Valley last year, after the latter ran into liquidity troubles, at a net acquisition cost of $9.47 per barrel; the acquisition price for Petro Canada Netherlands works out at $12.16 per barrel. In May Dana also paid Hyperdynamics $19.6 million for its 23% interest in an offshore asset in the Republic of Guinea.

“I suspect we will see a continued increase in consolidation because, one, the oil price is up, making investment attractive once again, and two, we’re seeing the Chinese and other national players buying up assets,” says one banker. “The trend is towards a clear separation between those that can obtain capital and those that cannot, and we will see consolidation towards those that can.”

Junior independents

Not all consolidation in the market comprises larger players snapping up struggling or unwanted assets at distressed prices. The standard model for independents is to develop an asset, then cash in. For instance, Kosmos Energy looks set to sell its 23.5% stake in the Jubilee oil field in Ghana for around $4 billion, either to ExxonMobil or the Ghanaian National Petroleum Corporation, depending on how the dispute over the sale plays out.

Last year Kosmos demonstrated the benefits for the smaller juniors of having a strong partner when, despite the credit crunch, it was able to raise $750 million of reserve-based borrowing on a single development asset – its stake in the Jubilee field, in which Tullow has the largest interest. The mandated lead arrangers on the Kosmos debt were Standard Chartered, BNP Paribas, SG, IFC, Absa Bank, Africa Finance Corporation, Credit Agricole and Cordiant Emerging Loan Fund III. At 500-550bp Kosmos had to pay around 150-200bp more for its debt than Tullow did for its borrowing base facility, but it showed that even during the worst of the credit crunch the smaller independents were still able to raise debt provided they had strong enough deals. In January Kosmos added a further $75 million debt from Credit Suisse, and the company has said it plans to raise further debt this year.

“The lesson learned is to be selective about the opportunities pursued,” says Chris Prior, co-head of the global oil and gas practice at Dewey & LeBoeuf. “There are limited resources available, and if you can form a JV with a larger company with deep pockets, do it.”

More recently, the PA Resources deal that closed in May showed that the underwriting market is now back for the smaller independents. The $250 million reserve base underwritten by Credit Agricole and Standard Bank, a five-year facility, is said to have received reverse enquiries from banks that left the market last year but are now looking to return. The sponsor, which has assets in Tunisia and Congo, is using the debt to refinance an existing $125 million facility, and simultaneously raised another $250 million through a rights issue, with the aim of reducing the company’s gearing. It marks a strategic shift for PA away from acquiring new assets and towards developing its existing assets in Congo.

Eastern promise

KrisEnergy’s $150 million loan from Standard Bank to finance the acquisition of a portfolio of assets in South East Asia was also notable for the degree of flexibility it granted to the borrower in finding assets to fund. This was secured on the back of the management team’s strong track record of finding and developing assets in the area with Pearl Energy, which it sold to the Abu Dhabi sovereign wealth fund Mubadala for $833 million just before the collapse of Lehman in 2008.

KrisEnergy had already secured a $500 million equity commitment from First Reserve at the end of 2009. The debt’s tenor is 1.5 years, extendable to two, and the plan is to put in its place a reserves-based borrowing facility when this term ends.

“Every independent is at some point heading towards the exit, as is every private equity trading company, either through a trade sale or an IPO,” says Richard Lorentz, KrisEnergy’s business development director. “With Pearl Energy we felt we had insufficient gearing at the IPO to make the most of the balance sheet, so this time we wanted to make sure we did.”

Of the $150 million borrowed from Standard Bank, $78 million has already been drawn down. The company has acquired stakes in 11 fields in total, ranging in size from 4% to 50%, with an average size of 29%. These include three exploration licences in Vietnam, two development and two producing assets in Thailand, two exploration licences and one producing asset in Indonesia, and a 25% stake in a Chevron operated field in Cambodia. So far the company has achieved 6,000 to 6,500 barrels of net production and acquired 22-23 million barrels of proven and probable reserves.

Meanwhile, Tullow increased its borrowing base facility in May, with HSBC and Bank of America Merrill Lynch joining HSBC and Merrill Lynch join Bank of Scotland, BNP, Credit Agricole, ING, SG, Standard Bank, Standard Chartered and RBS. Tullow completed the documentation in January to supplement its existing $1.885 billion borrowing base, which it closed last year, with a $250 million revolver, but the recent increase is thought to be greater than that.

Tullow has also been in the market this year for a couple more deals. It has sought debt for the $1.5 billion acquisition of Heritage Oil’s stake in the Ugandan assets they are joint venture partners in, and financial close is scheduled for the end of June for the recapitalisation of the Jubilee floating, production, storage and offloading vehicle, though this may well slip into July.

The total cost of the FPSO vessel, currently under construction in Singapore, is $875 million. The financing for the vessel will consist of an IFC A loan of around $50 million and a B loan of $519 million.

Going forward, in the next few weeks HSBC and Barclays Capital will close around $480 million of lending on the Tamar gas project in Israel, a significant find in pre-development. Earlier in June the consortium working the field, which was discovered in 2009, raised its reserve estimate by 15% to 8.4 trillion cubic feet. There is already an offtake agreement in place with Israel Electric Corp to buy at least 2.7 billion cubic metres a year from the field for 15 years, creating a revenue stream of between $400 million to $750 million a year.

The partners on Tamar gas, which requires a total capital investment estimated at $2.8 billion, and will reach first oil in 2012, are Noble Energy (36%), Isramco Negev 2 (28.75), Delek Drilling (15.625%), Avner Oil Exploration (15.625%) and Dor Gas Exploration (4%). HSBC and Barclays are lining up $430 million of funding for Delek and Avner, both subsidiaries of Delek Group, and $50 million for Dor Gas. Deutsche Bank is said to be providing the $550 million financing for Isramco Negev share of the venture.

Optimistic outlook

Lenders are talking optimistically about financing the upstream sector, though this optimism is seriously tempered by the fears over the fallout from the Deepwater Horizon disaster (see box), and turbulence in the Europe’s sovereign debt markets. The sovereign debt crisis hasn’t dampened lending to projects, but it has given banks the jitters, and has meant that though lending has rebounded, pricing has remained flat for the past seven to eight months, according to one banker.

To summarise the criteria that banks say they are looking at when deciding whether to fund a project in this new climate: they need strong management teams in place, where possible a good mix of development and producing assets in a portfolio, and projects need to be fully funded – if there are other partners in the venture, they need to have the finance in place for their stakes, and to completion, not just filling a gap.

But E&P investment decisions hinge on prices and reserves, and as one banker puts it, “the feeling is that the worst is over and that oil prices won’t be going back to 35 bucks a barrel.”