A New Approach to Energy Debt

Preamble:

Over the past two and one-half years we have seen a massive increase in bankruptcies of energy based companies.  This has been accompanied by multi-billion dollar write offs by those entities that had either loaned money to the oil companies or made direct investment in the companies.

There are many theories as to why this happened:  Over-supply in the market, loose credit by lenders, poor decisions by managers, and so on. 

It is our belief that one of the major causes of the crisis was that the structure of debt to energy companies was wrong for the lenders and wrong for the borrowers.  Much as the financial markets took years to understand that borrowing short term and lending long term was a recipe for disaster, the lending of money to energy companies without taking into consideration the volatility of the market was also a premise ripe for failure.

The Idea:  The lender to the oil sector should have the capability to participate in the upside potential of oil investments but to get this must be willing to participate in the downside potential.   

In today’s interest rate environment, the investment structure we are suggesting has substantial upside potential and yet we have greatly reduced the downside risk and come close to eliminating the bankruptcy risk.

Development of the Thesis: It is our belief that the risk of energy loans to both the lender and borrower can be substantially reduced by indexing the interest rate to the price of oil.  If the oil company’s debt service monthly is directly related to the price they receive for their oil in that month, their capability to survive is greatly expanded during bad times.  On the other hand, the oil company must, in exchange for this downside protection be willing to share with the lender when the market rallies.

Mechanics:  How can this be easily accomplished?  By floating the interest rate on the debt with the price of oil.  Each month the oil company computes their average price received for oil for that month and the rate they pay on the debt that month is based on that average price. 

How is this rate indexed?  There are numerous ways to do this but as a simple example we could index the price of oil between market levels of $15.00 a bbl and $140 a bbl, by starting the rate at 4.00% when prices are $15.00 and increasing it 25 basis points which each dollar increase in the price of oil.

Using this schedule, the rates the lender would receive on their loan for the month at the following prices:  $20 a bbl, the rate is 5.25%, $40 a bbl, the rate is 10.25%, at $80 a bbl, the rate is 20.25% and at $120 a bbl, the rate is 30.25%. 

The Result: We stress high returns, (15% to 18%) with market risk virtually eliminated.  The investor purchases the oil at a discount to the market.  This spread is locked in and the investor has a first mortgage lien on the oil contracted for.

Conclusion:    We have the capability of demonstrating this strategy is scalable and repeatable.  This strategy is unlike any investment in the energy industry and is proprietary.

We can exploit market inefficiencies readily using this strategy and the investor has the potential to receive superior risk adjusted returns being in a unique position to do so by utilizing this methodology.

 

 

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What do you do mean with energy based companies? What type of energy based companies, oil & companies, coal companies? be slightly more specific. Take in mind that many oil companies tend to go bankrupt because either bad administration or the oil field they expected to exploit weren't as good as they think they are, or they are simply filled with idiotic people without any knowledge of the industry (PDVSA)

there are not safe bets in the oil industry simply because there's no standardized models for the industry, there's fields that are profitable and very cheap to exploit, there are fields that are very expensive to exploit with thin margins, every single oil company is a world on it's own.

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On 9/7/2018 at 1:51 AM, BlackLine Resources said:

Development of the Thesis: It is our belief that the risk of energy loans to both the lender and borrower can be substantially reduced by indexing the interest rate to the price of oil.  If the oil company’s debt service monthly is directly related to the price they receive for their oil in that month, their capability to survive is greatly expanded during bad times.  On the other hand, the oil company must, in exchange for this downside protection be willing to share with the lender when the market rallies.

Interesting idea.

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