Academic journal article Economic Review (Kansas City, MO)

Do Adverse Oil-Price Shocks Change Loan Contract Terms for Energy Firms?

Academic journal article Economic Review (Kansas City, MO)

Do Adverse Oil-Price Shocks Change Loan Contract Terms for Energy Firms?

Article excerpt

Oil prices fell sharply in 2014 and have remained persistently low. While low oil prices may stimulate the U.S. economy overall, they can be disruptive to the domestic oil industry. A decline in prices may reduce oil firm revenues in the short run and increase uncertainty around future oil prices and earnings. These twin effects of oil-price uncertainty and lower potential earnings may, in turn, lower oil firms' creditworthiness, thereby reducing available financing for current operations and future investment.

A firm's creditworthiness determines whether it can get financing and, if so, under what terms. Perhaps the most important term is the interest rate "spread," defined as the difference between the loan's interest rate and a benchmark rate. Banks typically require a higher spread for borrowers who are less creditworthy to compensate for the borrower's increased default risk. As a result, external factors that affect certain borrowers' profitability and creditworthiness--for example, a shock to the oil industry--should be reflected in price changes on new loans.

In this article, we examine whether the relationship between creditworthiness and loan spreads for energy firms in the syndicated loan market changed after the 2014 oil-price shock. We use syndicated loans, which are jointly funded by several financial institutions, because the syndicated loan market is a major source of debt financing for oil firms. We find that credit conditions tightened following the oil-price shock in mid-2014. On average, the syndicated market shifted funding toward better quality (investment-grade) borrowers. After controlling for other loan, lender, and borrower attributes, we find that loans were priced higher after the oil-price shock for firms more closely involved in exploration and production relative to other oil firms. These firms were most likely to be adversely affected by the oil-price shock. Moreover, we find that within this subset of firms, spreads were higher for those without access to bond financing and those refinancing existing loans. We also find that larger banks charged higher spreads following the price shock, suggesting these banks are able to exploit their market power in times of distress. Together, our results suggest that credit conditions may not uniformly tighten across the oil industry after a price shock.

Section I describes the oil-price shock, its effect on firms in the oil industry, and these firms' prospects of obtaining financing. Section II introduces the data and the determinants of loan spreads in the syndicated loan market. Section III reviews our statistical analysis of loan spreads, accounting for nonprice terms and borrower and lender characteristics, to show how lending patterns changed following the oil-price shock.

I. Financing Energy Firms after the Oil-Price Shock

In June 2014, global crude oil prices began to fall dramatically. The price of U.S. West Texas Intermediate (WTI) fell from a monthly average of $106 per barrel in June 2014 to a monthly average of $30 per barrel in February 2016. (1) Chart 1 plots monthly average crude prices from 2007:Q1 to 2017:Q3 using the WTI benchmark. This recent oil-price shock--a peak-to-trough decline of 71.3 percent--was similar in magnitude to the 2008-09 peak-to-trough decline of 70.8 percent (Baumeister and Kilian). (2) However, the 2014 oil-price shock has been much more persistent than the 2008 shock. Monthly average crude prices rose above $100 several times following the 2008 price shock; in contrast, prices have not exceeded $60 since the 2014 price shock.

Effects of the oil-price shock

Oil firms may be able to weather short-term slumps in crude oil prices, but they face significant challenges during extended price declines. In general, the oil industry is competitive and largely composed of firms with high investment costs and little influence over market prices. While a sharp decline in oil prices reduces revenue, its effects on firm production and investment are less certain. …

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