American Oil and Gas Reporter - July 2016 - 93

ConventionCoverage: California Independent Petroleum Association
ance, they tended to draw down cash reserves and revolving loan accounts. Banks
often respond by implementing stockoutsource requirements or other financial
protections, or by limiting any such withdrawals without adequate communications,
he said.
Hedging Opportunities
As lenders adjust to the new capital
environment, many deals, in terms of
either acquisitions or development projects,
may require hedging, predicted Michael
Ross, executive director in Morgan Stanley's wealth management office.
"One of the fascinating things I have
heard has been that hedging traditionally
has been something the buyer does, but
there have been cases where it is cofunded by both the buyer and seller,"
Ross said. "I also view hedging like diversifying. In the annals of American
history, there are many family businesses
that started in one industry and-recognizing that that industry would have future
issues-diversified their cash flows into
other businesses. That is, in essence,
hedging."
Ross added other often-overlooked
aspects of hedging were tax impacts. Operators set up legal structures-such as recapitalization, family limited partnerships,
annuity trusts or buy/sell agreements-as
forms of hedging tax obligations, he described. "Beyond just commodity hedging,
as you set up your businesses looking
over the next five or 10 years, think
broadly in terms of the whole concept of
hedging and how you want to address
the future of your business," he advised.
Cockerham pointed out hedging helped
guarantee at least a portion of a company's
return on production. Typically, when
commodity markets climb, investments
return and operators resume drilling. But,
he said, after the latest downturn, most
operators were busy re-establishing their
budget priorities and reloading hedging
profiles.
"If you have an opportunity when you
see an uptick to start swapping some of
the positions in your hedging portfolio,
it is a tough but prudent thing to do, because there is no guarantee we will not
see dips again," he reflected.
Wells Fargo has seen additional hedging
activity as oil prices have climbed above
$50 a barrel, Rottinghaus observed, as
he discouraged CIPA members from
letting their optimism for getting the best
price keep them from installing hedges.

Guy Evangelista, with the Bank of Oklahoma, serves as moderator for a panel
discussion on capital markets. The event
was part of the California Independent
Petroleum Association's annual convention, held June 9-12 at the Meritage
Resort in Napa, Ca.

During the past several years, many
oil and gas acquisitions relied on high
amounts of leverage, he related. As banks
raced to capture some of that business,
requirements to hedge production from
those acquisitions decreased substantially,
Greenfield said.
"Looking forward, we are fairly conservative about how we think about leverage and debt you can put on a transaction,"
he posed. "The market will get more aggressive again, but one of the lessons we
learned is if you do choose to use leverage,
banks are going to expect more risks to
be taken off the table."
Based on deals signed so far in 2016,
Greenfield said it was not uncommon to
see 75-80 percent of proved, developed,
producing reserves forecast volumes
hedged for four or five years. Some deals
include a rolling two- or three-year hedging
requirement on PDP, he added.
Staving Off Bankruptcy
The oil and gas industry has seen
around 90 bankruptcies since January
2015, but Evangelista pointed out many
more companies were experiencing financial challenges that had not reached
that stage. He asked the panel to offer
suggestions on how borrowers could avoid
bankruptcy.
Rottinghaus recommended struggling
operators enter into early dialogues with
their lenders, providing the company's

plans for working out of its circumstances.
"It all starts with a conversation," he
said. "The mantra we have been using is
'share the pain.' If you need relief on
your covenants, as a senior debt lender, I
don't want to see that deal go sideways,
and I don't want the bank to have to
mark down that loan or even take control
of those assets. We are not in the business
of running companies."
Secured lenders dislike surprises, Cockerham said, noting that banks' early reaction after discovering financial woes
often is to use unsecured lenders as a fulcrum point for recovering investments.
Companies also have to make hard decisions when they are in distress, he said.
"You have to make a very clear decision-whether you are going to survive
this market or if you are going to be positioned to grow once the market comes
back," Cockerham said. "You can maintain
market share and hope you make it, but
what if the downturn does not end in six
or 18 months? At some point, you have
to swallow your pride and shrink-shut
plants or move facilities."
Operators also should know about alternative financing sources and structures,
Greenfield suggested. Those options may
help guide a company's response as it
negotiates out of a difficult borrowing
situation, he offered. He added that despite
the perception that being candid with
lenders could put operators at their mercy,
financial institutions were unlikely to use
that communication against them.
"Bankers are not merciless. They value
the relationship. Bankers are not waiting
to pull the rug out from under you. You
will enhance your position by conducting
an early dialogue," Greenfield maintained.
"Finally-and this is painful-another alternative is to sell a portion of your proved,
producing reserves. It hurts to do that, but
sometimes you have to take a step back to
take two steps forward."
❒

Coming In August
The Kansas Independent Oil &
Gas Association will hold its 2016
Annual Convention & Expo Aug. 1416 at the Century II Performing Arts
& Convention Center in Wichita, Ks.
See the Official Convention Section
in the August issue of The American
Oil & Gas Reporter.
JULY 2016 93

American Oil and Gas Reporter - July 2016

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