Banks Get Tough on Shale Loans as Fracking Forecasts Flop
Oil and gas companies face tightened credit after wells produce less than projected
By Christopher M. Matthews, Bradley Olson and Allison Prang Updated Dec. 22, 2019 wsj.com
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. Royal Dutch Shell PLC said Friday it will take a roughly $2 billion impairment, and 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. Banks have typically lent as much as 60% of that value. 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.
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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.
Not to pimp out a pro-E&P position, but there are merits to Hamm's proposal. Unlike conventional E&P, shale reserves are generally controlled and HBP longer by a single well / current production even with an extended depletion tail. The reserves are there; moving the time horizon to say 7-10 years generally will not change this position. Long to moderate term HBP properties generally do not contain aggressive downspacing requirements for continuous development in order to maintain the leases either (though as newer leases come due in the Permian and Eagle Ford areas this will not necessarily be the case). In those areas, all bets are off foregoing any allowances / amendments by lessors.
Pimp it, Dion! Yes, the reserve rules are outdated as are many regulations that were made for the age of conventional E&P. Curiously the industry does not seem to support a thorough review and update of all federal and state regulations to better match the new reality. Personally I would like for Louisiana to revisit the severance tax exemptions for "deep" and "horizontal" wells. Sauce for the goose, no?
The nice thing about the severance tax exemption is the fact that us royalty owners eventually get our share kicked backed to us, however many months later after an operator files the state paperwork. It tends to be a slow process, and us small interest holders need as much help as we can get per low NG prices and per the heavy deductions via the big whack of production fees, which used to not exist with the old vert wells with some of the original operators. Of course, that was over a decade ago, and so all of the newbie mineral owners who were brought into the fold by the horizontal/shale drilling do not have that old-timer perspective when it comes to almost actually getting the Henry Hub end-of-the-month strike price for their NG. Yet such used to actually happen for us old-school families who go way back to the good ol' days of much, much higher NG prices. Yep, you're kinda screwed if you do and you're sorta screwed if you don't, I guess, one way or the other.