concerns regarding the potential impact of a recession have weighed heavily on
the energy industry despite fundamentals remaining strong. Many industry
professionals have said that “fear of recession” is more concerning than the actual
impact a recessionary economy may have on the space.
with the demand destruction that occurred during pandemic, we saw consumption
easily outpace production as we came out of the trough. Still, with the market
back in balance, consumption and production continue along in rough equivalence.
the multiyear highs for oil and gas prices in 2022 the industry as whole is extremely
healthy from a financial standpoint. Balance sheets look strong, and many
companies posted solid cash flow. Despite the headwinds of commodity price
volatility at the start of 2023, players in upstream and infrastructure are
moving into the new year from a very stable position.
one of the biggest questions tends to be whether or not capital will remain
constrained moving forward.
2020, there has been a significant flight of capital from the sector. Indeed, some financial institutions were already
pulling back from the energy sector prior to the pandemic, but the global
economic challenges associated with pandemic made it easier for those capital
providers to withdraw altogether often because the volatility and ever-changing
variables exceeded their risk tolerance.
pandemic was not the only catalyst for the flight of capital from this sector.
Some financial institutions made a philosophical shift away from investing and
lending to the oil and gas industry regardless of market conditions resulting
in a limited number of remaining participants. With fewer banks to service the
sector, the selection process for which deals get done has become more
rigorous. This has had a significant impact on the industry’s ability to
we have seen some large corporate level consolidation occur, it has been more
difficult to align buyers and sellers at the asset level where stock is rarely
a currency, and sellers are primarily looking for all-cash buyers. And this
trend is expected to continue throughout the remainder of the year.
Adding fuel to
the fire, the limited availability of capital is not the challenge of late – interest
rates spiking throughout 2022 has significantly increased the cost of what
capital was available. The impact higher interest rates have had on asset
valuations cannot be overstated, and it was one of the primary factors
contributing to the slowdown in A&D last year.
As rates jumped
throughout 2022, the bid/ask spread between buyers and sellers widened
significantly as more expensive debt financing showed up in higher discount
rates and lower multiples for upstream and midstream asset valuations,
If a buyer did
secure a term sheet for the debt, the terms being offered for acquisition financing
were much tighter that what was previously the industry standard. Most banks
were willing to lend only 50% of the purchase price, and leverage was often
capped at 2x cash flow.
This would mean
buyers had to rely heavily on more expensive equity to round out the purchase
price, and in many cases, this drove valuations to a level unacceptable to
sellers who could still cash-flow assets at attractive commodity prices. This downward pressure on valuations
encouraged many sellers to hold assets as opposed to transacting.
of that said, there looks to be some light and the end of the tunnel. Although
we saw the Fed increase interest rates again in February, the
quarter-percentage point was a welcome departure to the rate hikes the market endured
last year. There is an expectation of a similar increase on the horizon, but it
is possible we see a pause to rate increases sometime this year as the Fed
nears its target and talks of a soft landing re-emerge.
some pools of capital are finding their way back to the sector. A number of
private credit funds have stepped up to fill the void left by commercial banks
who exited the space. This segment of alternative capital providers can usually
offer more flexible terms and structures which provide companies with greater
access to capital.
some smaller regional banks and boutique funds are serving smaller oil and gas
companies, and so there are becoming enough capital providers to call on for
almost any deal size.
a financially healthy industry can solve for some of the challenges itself. For
a market where debt financing is more elusive, a surplus of cash on the balance
sheet can be part of the remedy, and this option should be further enhanced as
many out-of-the-money hedges roll off in the first half of the year.
starting to hear chatter about creative deal structures being more strongly
considered as a way to usher transactions across the finish line as well, and
with the greater flexibility offered by the alternative capital providers, we
could begin seeing more highly structured deals take place. Ultimately,
companies still need to grow.
areas for both development and infrastructure are less than favorable for now
and do not fit the risk profile for most investors and stake holders.
Accordingly, we can expect to see continued consolidation in the top tier
basins as players seek to exploit opportunities to expand and achieve economies
this industry, as with many others, often opportunity can be found in the midst
of challenging markets. Volatility will always accompany a commodities based
sector, but this industry has always found a way to push through the
challenging times successfully – and we can expect the same this time. It’s
encouraging to remember that bear markets eventually end in bull markets. P&GJ
Jason Reimbold is the managing director of energy
investment banking for BOK Financial Securities, member FINRA/SIPC and a
subsidiary of BOK Financial Corporation. He has worked in energy finance since
2005 and currently offices in Dallas. Reimbold earned a BSBA in finance from
the University of Tulsa. Prior to graduation, he served in the United States
Army and U.S. Army Cavalry from 1999 to 2003.