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Oil collapse hurts drillers far more than bankers

Scott Tong Jan 20, 2016
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Oil collapse hurts drillers far more than bankers

Scott Tong Jan 20, 2016
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Today a barrel of West Texas Intermediate oil sold for less than $27. That’s six percent below yesterday. The last year has brought a disastrous bust for oil and gas producers, and also financial challenges for their lenders.

The last oil bust of 1986 brought a Texas banking rout.

“Basically all the major Texas banks either failed or were bought out by a major East coast bank,” said longtime bank analyst Charles Peabody of Portales Partners.

Since then, energy finance has changed dramatically, and fewer alarm bells are going off even with oil selling at a quarter of its recent peak price. Oil lending has spread out — among banks, hedge funds, private equity financiers and others. And for all the exuberance of the fracking boom, many large banks remained disciplined.

“There is a silver lining from the financial crisis,” said Mike Mayo of the investment firm CLSA. “And that is that the banking industry doubled down on ensuring that they lent to the best borrowers. This is not The Big Short, part two.”

At least it’s not for banks. For many drillers, their endless well of money and finance is fast drying up. Today, an oil producer may pay out $50 to pump a barrel that sells for only $27. Energy firms’ credit lines were cut an average 39 percent last fall, by one estimate. And many drillers bought guaranteed high selling prices — called hedges — that will expire soon.

“With less hedge — think of it as price insurance — the companies will be more exposed to potential borrowing base reductions,” said Buddy Clark of the energy practice at the law firm Haynes Boone. “And you would expect less of that protection going into 2016.”

Going forward, a question will be, what happens when an oil or gas company can’t pay its debt? It may be a tough call for the bank. It can push liquidation or bankruptcy and take a loss. Or it can keep lending and cross its fingers that oil prices will recover soon.

“The old adage used to be ‘a rolling loan gathers no loss.’ Keep rolling those loans when they came due in an effort to keep their client afloat,” said Peabody. “But history shows the losses actually grew over time.”

Peabody said drillers, and their bankers, are going through a two to 2.5  year period of pain that could last well into 2017.

Correction: A previous version of this post misstated Buddy Clark’s last name. The text has been changed.

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