Enhancing the monetisation of future oil and gas production

One of the biggest concerns for small and mid-size shale oil and gas companies is that they are largely self-financed. They lack the deep-pockets that traditional energy firms can rely on, which means that the viability of their projects could quickly be lost in the event of interest-rate fluctuations. If the system is going to work, there needs to be a better way to finance the sector to create more certainty.

Many small and mid-size shale oil and gas exploration and production companies (E&Ps) are typically rated below investment grade by the rating agencies. This makes their access to debt markets relatively expensive in comparison with investment-grade companies, particularly when low energy prices put profit margins under pressure.

RBL has been the answer…

Reserve base lending (RBL) has been instrumental in providing the sector with access to low-cost bank debt finance, allowing the rise and expansion of numerous small and mid-size players in shale. It’s a structure that protects lenders’ collateral, while releasing funds for the drilling and expansion of oil and gas reserves.

Operational improvements in the way that shale oil and gas companies are run have been scrutinised in several studies since the oil price crash, but financial efficiency gains have been less widely discussed.

The selloff put the RBL structure to the test. Although the structure proved generally resilient, the low price of oil and the bankruptcies it triggered in the sector led to a series of improvements in RBL covenant structures. As a result, the banking sector has become more efficient and selective in E&P lending.

…but it may not be forever

This lower risk tolerance among lenders has been balanced by the persistence of low interest rates, which have helped maintain the banks’ commitment to the sector.

This creates a risk that higher interest rates could wipe out a substantial proportion of the benefits that RBL has delivered to small and mid-sized E&P operations.

From this perspective, with interest expenses comprising up to a third of the total cash cost of E&Ps, RBL and the outlook for shale oil and gas finance could be seen as looking bleak. Since shale oil production is highly capital intensive, the high cost of debt could drive up total cost of production to an unsustainable level if oil prices remain low or fall further. This high cost of capital would have less impact on larger players with deep financial reserves and access to debt and equity capital markets at a lower cost.

Before this happens, the industry needs to have a debate about how it should be funded and potentially investigate some of the innovative options that have begun to be developed around technologies such as blockchain. If it doesn’t commit to having these discussions now, the crisis could be upon us before we have time to react.

PermianChain Technologies is investigating ways to harness the power of blockchain technology, data science and artificial intelligence to monetise proven unproduced oil and gas reserves. The PermianChain, which already has a pipeline of millions of barrels of oil equivalent in potential reserves to be listed on its platform, intends to revolutionise the way that potential reserves are financed, bought and sold on a permissioned-access trust-protocol. The firm is in the process of applying to become a regulated private financing platform allowing trading and investment platform of digitized hydrocarbon assets.

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