By Christopher M. Matthews, Bradley Olson and Allison Prang
Some of the banks that helped fuel the fracking boom are
beginning to question the industry's fundamentals, as many shale
wells produce less than companies forecast.
Banks have begun to tighten requirements on revolving lines of
credit, an essential lifeline for smaller companies, as these
institutions revise estimates on the value of some shale reserves
held as collateral for loans to producers, according to people
familiar with the matter.
Some large financial institutions, including Capital One
Financial Corp. and JPMorgan Chase & Co., are likely to
decrease the size of current and future loans to shale companies
linked to reserves as a result of their semiannual reviews of the
loans, the people say. The banks are concerned that if some
companies go bankrupt, their assets won't cover the loans, the
people say.
JPMorgan Chase declined to comment. Capital One didn't respond
to requests for comment.
The tightening financial pressure on shale producers is one of
the reasons many are facing a reckoning going into next year.
Chevron Corp. said Dec. 10 that it plans to take a charge of $10
billion to $11 billion, roughly half of it tied to shale gas
assets, which it said won't be profitable soon. Other companies are
expected to follow suit in writing down assets, according to
analysts and industry executives.
The heat is greatest for small and midsize shale producers,
including many whose wells aren't producing as much oil and gas as
they had projected to lenders and investors. Some of those
companies may be forced out of business, said Clark Sackschewsky,
the managing principal of accounting firm BDO's Houston tax
practice. Large companies are likely to weather the blow because of
their size and global asset diversity, but for some smaller shale
operators, tightening access to bank loans could prove
disastrous.
"We've got another year under our belts with the onshore
fracking assets, which includes less than optimistic reserves
results, less production than anticipated, a reduction in capital
investment into the market," Mr. Sackschewsky said.
Oil and gas producers expect banks to cut their revolving lines
of credit by 10% as a result of the reviews, according to a survey
of companies by the law firm Haynes & Boone LLP. The cuts may
be more severe, say some people familiar with the reviews.
Banks have extended billions of dollars of reserve-backed loans,
though the exact size of the market isn't known. JPMorgan said in a
regulatory filing in September that it has exposure to $44 billion
in oil and gas loans, and Capital One said in October it has
extended more than $3 billion in oil and gas loans. It wasn't clear
for either bank what proportion of those are backed by
reserves.
Banks have typically applied a 10% discount to the value of
reserves, meaning a shale company could borrow against 90% of its
reserves as collateral. But some are now discounting the value by
as much as 20%, the people say.
Meanwhile, some regional banks have begun writing off bad energy
loans. Net charge-offs shot up at Huntington Bancshares in the last
quarter. The Ohio-based lender attributed the move primarily to two
energy loans where the borrowers' production had not met
expectations, Huntington Chief Executive Officer Stephen Steinour
said in an interview.
"Geology and the assumptions were just flawed," Mr. Steinour
said.
Many investors have lost faith in the viability of shale
drillers, as natural-gas prices stayed low and many companies broke
promises on how much their wells would produce and when they would
begin to turn a profit.
As investors have retreated, cracks have begun to show. Energy
companies accounted for more than 90% of defaults on corporate debt
in the third quarter, according to Moody's Investors Service. There
were more than 30 oil-company bankruptcies in 2019, exceeding the
number in 2018 and 2017. Exploration and production companies are
now carrying more than $100 billion in debt, according to Haynes
& Boone.
Skepticism among banks has grown in part because lenders have
more closely scrutinized public well data on production and seen
that it is falling short of forecasts, as a Wall Street Journal
analysis showed earlier this year.
Specifically, banks have begun questioning shale producers'
predictions about their wells' initial rate of decline, which are
proving overly optimistic, according to engineers. If shale wells,
which produce rapidly early and then taper off, are declining
faster than predicted, questions arise regarding how much they will
ultimately produce.
Some lenders have flagged publicly that they will be less
generous with loans in the future. "With respect to any new energy
loans, we are highly cautious; it's a very high bar we must clear,"
said Paul B. Murphy, CEO of Cadence Bank, in an October call with
analysts. The firm operates in Texas and the southeastern U.S.
Bank lending has slowed across the board in the country's
hottest drilling region, the Permian basin in West Texas and New
Mexico. After leading Texas last year, loan growth in the region
shrunk to 4.8% below the state's 7.5% average in the last quarter,
the Federal Reserve Bank of Dallas said Thursday.
More than a decade into the shale boom, investors are trying to
wrap their arms around the true value of producers' assets, said
Michelle Foss, an energy fellow at Rice University's Baker
Institute. for Public Policy.
"There is a struggle now for investors to determine what things
are actually worth," Ms. Foss said.
Dwindling access to bank loans will put more pressure on an
industry that has already lost access to other sources of money.
Without new cash infusions, many companies may be unable to drill
their undeveloped reserves, which could further diminish the value
of their assets.
Some shale companies have been lobbying the Securities and
Exchange Commission to change its rules governing reserves
reporting, allowing them to count undeveloped assets as reserves
for a longer period. The SEC currently allows oil and gas producers
to report reserves as "proved" if the companies plan to develop
them within five years.
In an August letter to the SEC, Continental Resources Inc., one
of the largest shale companies, pushed for the regulator to extend
that period to 10 years. The company, founded by the billionaire
prospector Harold Hamm, said its proved reserves would be around
16% higher with such a rule change.
A Continental spokeswoman declined to comment. An SEC spokesman
didn't respond to a request for comment.
Write to Christopher M. Matthews at
christopher.matthews@wsj.com, Bradley Olson at
Bradley.Olson@wsj.com and Allison Prang at
allison.prang@wsj.com
(END) Dow Jones Newswires
December 22, 2019 05:44 ET (10:44 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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