Managing Risks in the Volatile Energy Industry

By Taylor, Mary Jo; Beans, Kathleen M. | The RMA Journal, March 2013 | Go to article overview

Managing Risks in the Volatile Energy Industry


Taylor, Mary Jo, Beans, Kathleen M., The RMA Journal


Hydraulic fracturing, or "fracking," presents opportunities and challenges for lenders. In this interview with RMA Journal Editorial Advisory Board member Mary Jo Taylor and Journal editor Kathleen M. Beans, Bart Schouest, deputy group head for the Wells Fargo Energy Group, discusses the risks and opportunities in lending to this industry.

RMAJ: What are the top two or three risks you consider when lending to the oil and gas industry? Are they different for oil drilling versus hydraulic fracturing?

Schouest: In every transaction we evaluate, one of the key criteria we consider is the management team. That issue is critically important in the oil and gas world of today where we have to contend with a number of risks: volatile and disjoined oil and gas prices, oscillating oilfield costs, production performance, and an increasingly complex regulatory environment. We must be comfortable that the management team we are lending to has the experience and depth to properly manage these types of issues.

RMAJ: Do you have staff economists or others who constantly evaluate price trends in these commodities? If so, how does their pricing information impact your lending decisions?

Schouest: In each lending evaluation, we model clients' production using an internally generated policy price deck. We make regularly scheduled updates to these commodity pricing parameters by using a number of inputs, including the view of our internal economists. We also rely on a variety of other internal and external resources that are equally important.

Our price deck forecasts are designed to reflect our intermediate view of commodity prices, and the values employed are generally viewed as conservative. They are designed to be commensurate with the risk profile we are taking as senior lenders. We strive to avoid making sharp changes in our price forecasts over a short period of time. We tend to have a smoother evolution in our price trends than the underlying commodity markets, thereby providing our clients with adequate flexibility to respond to changes in market conditions.

RMAJ: How has this drilling boom impacted your lending to independent oil and gas companies in terms of lending capacity, underwriting, conditions, covenants, and so on? Schouest: The "drilling boom" hasn't really altered the manner in which we evaluate our clients' bank debt capacities, as our methodology has been very stable and consistent for many years. I would say the same applies to the broader energy bank lending market, which has operated with similar, established lending parameters for many years.

Banks typically lend to the independents based on established production volumes and the associated cash flow forecasts. In most cases, credit agreements call for the borrowing capacity to be reevaluated every six months through a borrowing base redetermination process, designed to reflect changes in production levels, operating expenses, capital costs, and commodity prices.

Overall, the "boom" has led to a higher level of deal activity, with many significantly sized property transactions occurring as many players reposition their asset portfolios to reflect the important role that resource plays have developed in the industry.

RMAJ: How do you define your appetite for risk in this industry? Do you set concentration limits? Are there geographical limits? For instance, do you seta limit for lending to companies drilling in the Bakken oil fields versus those drilling in the Marcellus or Utica shale region?

Schouest: We haven't been restricted by any such limitations. Of course, we evaluate individual client risks to ensure we are creating a sufficient risk management balance in any single transaction and adequate overall portfolio granularity, but beyond that we don't have any regional or basin limitations, per se.

I would emphasize that Wells Fargo has a strong appetite to continue growing our presence in the oil and gas industry. …

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