Commentary: Are Energy Lenders About To Be Burned Again?Phillip L. Zweig
When Mahan Rowsey Inc., a high-rolling Oklahoma City oil and gas concern, went bust in 1982 and helped bring down the infamous Penn Square Bank along with it, few would have expected that W.E. "Billy" Rowsey, the company's co-head, would ever be welcome in a bank again. But banks are seriously considering making him a loan now. Rowsey, CEO of Araxas Energy Corp., with $100 million in assets, says he has rebuilt his "credibility and overcome the `Penn Square' stigma."
Not since the early 1980s has the action been so frantic, propelled by a robust economy, firm prices, and an abundant flow of oil and gas financing. Commercial and investment bankers, private equity investors, and even newly created finance units of pipeline companies are tripping over each other to underwrite loans, high-yield debt, and equity for oil-service companies and independent producers.
"LOOSER." But the zeal to deal conjures up images of the early-1980s energy-lending debacle that decimated scores of banks--carnage that some of today's players seem to have forgotten. While oil and gas companies are surely healthier and better managed now, several top energy lenders say that telltale signs of irrational exuberance are cropping up in oil patch deals. Says Tom Foncannon, head of the energy and minerals unit at Norwest Bank Colorado: "Things are becoming looser. I do hope that some of the things we're starting to see don't result in a lot of the craziness that happened before."
Banks are leery of talking about specific deals. But they acknowledge that some financial institutions are underwriting deals on drilling rigs and riskier properties, including proven but nonproducing reserves, and betting that oil prices will rise 3% or 4% a year, to as much as $40 a barrel from the current $21 level. Loan spreads are shrinking, suggesting that lenders aren't always being compensated for these risks. From 1994 to 1996, spreads over the London Interbank Offered Rate fell 19%, to 122 basis points on loans to BB-rated companies, compared with a drop of less than 16% on similar commercial and industrial loans, says Loan Pricing Corp. Terms are being stretched, and covenants, such as leverage restrictions, are being scrapped. In March, Chesapeake Energy Corp., a highflying Oklahoma City independent whose shares fell more than 50% since November, to 16 1/2 on May 14, was able to increase its two private debt issues by 50%, to $300 million, on favorable terms.
To be sure, some energy experts insist that comparisons with the bad old days are misplaced. They say many companies that survived the '80s now eschew unnecessary debt. Recent innovations, such as 3-D seismic imaging and directional drilling, have dramatically boosted exploration success ratios and lowered finding costs. They add that the industry is now driven by market forces, rather than by tax shelters and price regulation.
"Balance sheets have gotten better. The memory [of the 1980s debacle] is very clear in survivors' minds," says H. Allen Turner, vice-president for corporate development of debt-free Devon Energy Corp., an Oklahoma City independent producer.
Nonetheless, evidence of aggressive financing and the reasons for it are not hard to find. For one thing, financiers--from veterans to Johnny-come-latelies--are lending and investing more money than they have in years. Institutions such as Bankers Trust Corp., which retreated from energy lending in the 1980s, are coming back strongly. Foreign institutions such as Bank of Montreal and Banque Paribas are competing intensely for deals with veterans such as Chase Manhattan. And Japan's Sanwa Bank Ltd. has set up a new energy unit.
Adding to the pressure are several big production and pipeline companies. Following the lead of Enron, the Williams Cos., and a Shell Oil joint venture, for example, have created production finance units. Almost across the board, deal volume was up sharply in 1996 and continues at a brisk pace. Last October, Apache Corp., a big independent producer, kicked off a party by issuing a $150 million 100-year bond, a milestone that triggered a rash of similar offerings. But if oil patch history is any guide, the party won't last forever.