Restructuring in the oil and gas sector: what does the future hold?
Howwill these challenges impact restructuring activity in the market?
What is the current state of play?
By and large, the oil and gas sector was recovering quite well from the last downturn and activity levels had increased through 2018 to 2019. However, recent events have hit the sector hard and we have started to see cost cutting and cash preservation measures such as deferral of capital expenditure projects, deferred maintenance and unfortunately a series of redundancy programmes across the industry. Companies are operating in crisis mode and taking steps to reduce costs, conserve cash and access liquidity. For some E&P companies, there has been short-term revenue mitigation through oil price hedges. However, hedge benefits will recede as we enter Q4 2020 and will offer little protection in 2021. Another feature has been some players reducing or shutting-in production to preserve the hydrocarbons in the reservoirs for better times hopefully ahead. The management teams of oil and gas companies are adept at managing their cost base well in tough times – they’ve been in a similar situation before – and the quirk with this commodity is that companies do not need to keep producing it if the price drops, they can just stop until the market begins to improve. But that does not mean challenges can be overcome easily. Initially, the hardest hit have been the oil service companies, especially those that focus on exploration and development where work has dried up. Those with a project backlog, albeit reduced, through 2020 are looking at activity levels next year and beyond – particularly businesses across the supply chain that have had work stopped or put on hold. We know these businesses are already putting measures in place to address the issues they’re facing, be that looking at headcount or deferring capital expenditure but, for some, the main concern is about their ability to win replacement work for next year and further ahead.
In previous cycles, lenders have driven restructuring activity and have generally preferred to ride difficulties out in expectation of oil prices rebounding. Additionally, unlike many other industries, lenders have been unwilling to take equity control, especially for E&P companies, given various concerns over consolidation, PR, environmental risks and decommissioning liabilities. As a result, the vintage of financial restructurings from the last downturn was typically ‘amend and extend’ type restructurings. Debt would be left in place but maturities would be deferred. Repayment obligations would be re-set based on a revised financial model predicated on increasing oil prices. Insolvencies were a rarity and most restructurings were implemented consensually. This has left a position today of many over-leveraged debt structures with unrealistic amortisation schedules at current oil pricing. In most situations further financial restructurings would benefit businesses. Arguably the lenders’ strategy may be the same as before. Anything else is likely to crystallise a large loss which may just be unpalatable. However, there are some signs that financial restructurings may look a bit different going forward.
What might change in this cycle?
In the UK restructuring and insolvency industry, partly as a response to COVID-19, there have been a number of recent changes. Firstly, the recent insolvency reforms in the Corporate Insolvency and Governance Bill 2020 have provided new tools, in particular a Restructuring Plan, which provides far greater scope than previous restructuring tools to compromise, or cramdown, liabilities or shareholders. This could mean that restructurings cut debt ‘deeper’ and/or tackle a wider range of stakeholders and possibly ownership structures. Lenders will want to see sustainable capital structures, either through equity injections or deleveraging financial restructurings. Additionally, we have seen increased use of ‘light touch’ administrations, where administrators delegate certain responsibilities back to directors in order to achieve a more collaborative, effective and lower cost insolvency process. In a highly regulated sector such as the oil and gas industry – which faces operational, health and safety and environmental challenges – this approach could prove effective.
How has the COVID-19 pandemic impacted the sector?
Most crucially, the COVID-19 pandemic has prompted unprecedented operational and welfare issues, in some cases with employees and contractors stranded offshore. However, beyond these immediate welfare concerns, COVID-19 is weighing heavily on sector confidence and in particular long-term oil demand. This could impact long-term resilience within the sector, which may result in a higher risk profile for investor returns.
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