Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Allaway and I'm so Joe. We have seen
Speaker 1: an absolutely stunning drop in the price of oil. Uh,
Speaker 1: that is, to put it mildly, I would say the
Speaker 1: stunning drop, I mean stunning, stunning is mild. You know,
Speaker 1: oil had already been precipitously declining all year mid concerns
Speaker 1: about economic growth and supply, and then of course over
Speaker 1: the weekend Saudi Arabia just came out and shocked the world. Yeah,
Speaker 1: so Saudi Arabia basically said it wasn't going to extend
Speaker 1: the production cut agreement that had kind of provided a
Speaker 1: floor for oil prices for a few years. Now. Oil
Speaker 1: promptly fell something like over the weekend, which was the
Speaker 1: biggest fall since the First Gulf War, and it's recovered
Speaker 1: a bit since then. At the time of our recording,
Speaker 1: I think Brent, the global benchmark for cruit is trading
Speaker 1: at thirty seven dollars a barrel, and w t I
Speaker 1: in the U S is at thirty three dollars a barrel.
Speaker 1: But it is still massively bad news for the U
Speaker 1: S energy sector. Yeah, absolutely right. When oil opened and
Speaker 1: so just so that people understand the timing. Obviously we're
Speaker 1: recording this Tuesday, March tenth. But when oil opened this
Speaker 1: past Sunday and everyone was watching with their jaws on
Speaker 1: the floor at that crash, the only thing that I
Speaker 1: sort of that it reminded me of at the time
Speaker 1: is like when bear Stearns opened to two dollars to share.
Speaker 1: It was that, like it was just that much of
Speaker 1: a dislocation that I can't think of anything else sort
Speaker 1: of comparable in the last Okay, seeing that move, Yeah,
Speaker 1: a huge dislocation in the market, a big surprise for
Speaker 1: OPEC watchers. But all of that is sort of bad
Speaker 1: enough for the energy patch. But there's something that makes
Speaker 1: it even more painful if you can believe it, which
Speaker 1: is that this is coming, this oil price drop is
Speaker 1: coming at a very special time in the energy market.
Speaker 1: Right around this time of the year, we have something
Speaker 1: known as the borrowing base redetermination process or season, which
Speaker 1: is basically the time in which banks reassess their loans
Speaker 1: to energy companies. So those loans are based on an
Speaker 1: estimate of the value of their oil and energy related assets.
Speaker 1: So the fact that they're going to be doing this
Speaker 1: right after oil fell is really not good, right, It's
Speaker 1: terrible timing because a as you mentioned, oil is getting clubbed,
Speaker 1: and then on top of every thing, because of the
Speaker 1: volatility and financial market, there is not a particularly high
Speaker 1: amount of risk appetite to fund anything, let alone extremely
Speaker 1: risky energy players who's uh suck the commodity that they
Speaker 1: sell just player a day. Absolutely, and the interplay between
Speaker 1: the U S energy sector and capital markets is a
Speaker 1: really interesting one. So we're going to dive into it
Speaker 1: on this episode. We're going to get maybe a little wonky,
Speaker 1: but it'll be fun. Our guest for this episode is
Speaker 1: Buddy Clark. He's a partner at the law firm Haynes
Speaker 1: Boone based over in Houston. He's also the author of
Speaker 1: Oil Capital, The History of American Oil, Wildcatters, Independence and
Speaker 1: their Bankers, which is basically all about the relationship between
Speaker 1: energy and capital and banking. So he's really the perfect
Speaker 1: person to discuss this. Buddy, thanks so much for coming on.
Speaker 1: Thank you for u inviting me so Buddy, I mentioned
Speaker 1: that you're based out in Houston. Joe mentioned the massive
Speaker 1: reaction to the oil price fall over the weekend. What
Speaker 1: reaction did you see out in the oil patch in
Speaker 1: Texas well, I think everybody's seeing a little bit of
Speaker 1: shell shock at the moment and waiting to see where
Speaker 1: the prices settle out. Obviously, it's been a major drop
Speaker 1: in prices and that's significant for producers all up and
Speaker 1: down the value chain as far as their size and
Speaker 1: debt leverage ratios. But I think right now people are
Speaker 1: still hold their breath to sea where that's going to
Speaker 1: fall out. You know, you saw a couple of the
Speaker 1: larger independence announced they were just gonna cut back significantly
Speaker 1: on drilling capital expenditures, and that's probably going to be
Speaker 1: the theme coming out for the next couple of weeks
Speaker 1: from all the publicly recording companies. Well, there's a lot
Speaker 1: of a lot of different moving parts here. Obviously, the
Speaker 1: move from Saudi Arabia Carrington, the reporting was precipitated by
Speaker 1: tension between Saudi Arabia and Russia. I think are the
Speaker 1: report called it Saudi Arabia firing a shot in the
Speaker 1: oil price war. But talk to us about the OPEC
Speaker 1: politics as it relates to their desire to see carnage
Speaker 1: within U u s domestic energy, which of course is
Speaker 1: as everyone is noted, has made OPEC or OPEC plus
Speaker 1: less of an important entity than it used to be
Speaker 1: in sending the global price. Well, I guess historically we've
Speaker 1: seen OPEC do this at least three times, in the
Speaker 1: mid eighties and Thanksgiving and now again. Uh it's I
Speaker 1: wouldn't ascribe malintent by OPEC. Are the Saudis to put
Speaker 1: all the U s producers out of business? It's just
Speaker 1: their goal to maintain their market share, and if that
Speaker 1: means they're losers out there, then that's just the way
Speaker 1: capitalism and the oil markets work. But I think clearly
Speaker 1: it has been the revolution of the US producers in
Speaker 1: the shale field that has triggered this massive influx of production,
Speaker 1: dramatic increase in US deliverability, and made the US number
Speaker 1: one exporter of oil. That's obviously gotten the attention to
Speaker 1: the Saudis and Russia as well. Um So, the goal
Speaker 1: that OPEC had in the eighties and again in was
Speaker 1: just we're tired of giving up our market share the
Speaker 1: profit oil prices for the benefit of other producers. And
Speaker 1: they've gotten to that point again because I suspect the
Speaker 1: Russians did not want to continue to subsidize, not necessarily subsidize,
Speaker 1: but but provide a floor for US producers to continue
Speaker 1: to produce. And we'll have to now see how this
Speaker 1: all plays out in the next couple of weeks or months.
Speaker 1: Hopefully won't be in the next couple of years, but
Speaker 1: there's really no way of knowing right now what the
Speaker 1: implications are, right. So, I was looking at one set
Speaker 1: of estimates earlier today which said the oil in the
Speaker 1: low thirty dollars a barrel basically means that almost all
Speaker 1: of US shale is now unprofitable. Uh, That particular forecast
Speaker 1: said only five companies in two areas of the country
Speaker 1: now have break even costs that are lower than the
Speaker 1: current oil price. What's your sense of the break even
Speaker 1: rate of US shale because there's a lot of debate
Speaker 1: on this topic. Yeah, and there's a lot of different
Speaker 1: metrics one can use. If you're talking about what is
Speaker 1: the cost to go out and acquire the land and
Speaker 1: to drill and complete and to bring onto production a
Speaker 1: well that numbers can be a whole lot higher than
Speaker 1: those producers that have current wells that are producing. How
Speaker 1: much does it cost them in the field just to
Speaker 1: continue to get the production out of the ground. Uh.
Speaker 1: I think the least operating expense for existing production wells
Speaker 1: that are currently online. I think that cost is lower
Speaker 1: than thirty dollars to barrel. So it's not like producers
Speaker 1: are shutting in wealth because they can't recover their cost
Speaker 1: of producing, but the ability of the producers to actually
Speaker 1: go out and drill wells, even on lands of that say,
Speaker 1: they've already sunk the cost on land acquisition and now
Speaker 1: it's just the drilling completion cost. Those are that capex
Speaker 1: is going to be cut back. That's what diving Back
Speaker 1: said they were going to do. A number of other
Speaker 1: producers are are starting to pull back from their drilling plans.
Speaker 1: And in that number various I guess, from basin to basin.
Speaker 1: But the lowest I heard was of barrels. So if
Speaker 1: prices they are below forty five over a long term,
Speaker 1: over you know, the predicted life of the wells production,
Speaker 1: then if you can't you can't recover that cost, you're
Speaker 1: not going to drill the ells. How does that compare
Speaker 1: either the costs of new drilling of wells or the
Speaker 1: cost structure of existing wells that are already uh pulling
Speaker 1: oil out? How much of costs come down you mentioned,
Speaker 1: I think Thanksgiving or was when the last time we
Speaker 1: saw such a dramatic move. Are the domestic players leaner?
Speaker 1: Have they got their cost structures more competitive since that time? Yeah,
Speaker 1: that's that's a great question. That's I think one of
Speaker 1: the uh number of ways that OPEC underestimated the impact
Speaker 1: of their Thanksgiving price drop. They assumed that producers costs
Speaker 1: were static and that the technology was static. But in fact,
Speaker 1: uh necessity being the mother of invention, the producers in
Speaker 1: the US kind of took it in stride. They were
Speaker 1: probably a lot more overweight back in coming off of
Speaker 1: barrel price just a few years before that it was
Speaker 1: still a hundred dollars of barrel and there about that summer,
Speaker 1: so producers had a lot of fluff, let's say, in
Speaker 1: their overhead and the way they were doing business. But
Speaker 1: when the price was crammed down, the producers adjusted and
Speaker 1: adjusted quickly. And not only did they lean on the
Speaker 1: drillers and and other oil field service providers to cut
Speaker 1: their cost, but they found ways to maximize their drilling efficiency.
Speaker 1: Instead of drilling one horizontal well per drill pad, they
Speaker 1: you know, developed a six well pad drilling with drilling
Speaker 1: rigs that they wouldn't have to move by by dozers.
Speaker 1: They just have caterpillars on the drilling rigs, and the
Speaker 1: drilling riggs themselves were mobile. And the way where they
Speaker 1: were able to get cost down considerably in order to
Speaker 1: adjust to the new world prices. What about now? What about?
Speaker 1: Have we already discovered or invented all the cost saving
Speaker 1: measures that are possible to invent? And I would say
Speaker 1: that the past would be predictive. There's more and there's
Speaker 1: more ways to invent in the oil field industry than
Speaker 1: you can imagine. And and there are people right now
Speaker 1: thinking of ways how do we cut costs on drilling,
Speaker 1: how do we cut costs on completion, etcetera. So, while
Speaker 1: there's not as much bluff, I don't think the industry
Speaker 1: is going to raise a white flag and say we're
Speaker 1: you know, we're not going to compete anymore. They're they're
Speaker 1: going to be looking for ways to cut costs and
Speaker 1: to compete in global markets. Yeah. I remember back in
Speaker 1: two thousand and fifteen doing a story on this, and
Speaker 1: some of the energy companies were really creative in cutting costs,
Speaker 1: like even switching light bulbs and standardizing the nuts and
Speaker 1: bolts they were using, like actually getting down to the
Speaker 1: nuts and bolts of their operation in order to save costs.
Speaker 1: It was pretty amazing. Just on that note, what's the
Speaker 1: easiest way for an energy company to try to ride
Speaker 1: out the current route in oil? I imagine cost cutting
Speaker 1: is one of them. Cutting back on investment is another
Speaker 1: obvious choice. But what's the sort of easiest for knee
Speaker 1: jerk reaction that you would expect most firms to have here? Well, um,
Speaker 1: Historically the first reaction is to lean on their provide
Speaker 1: their service providers, UH, and to cut back on expenditures
Speaker 1: they don't need to make. For your audience is not
Speaker 1: fully aware of this, Oil and gas leases are subject
Speaker 1: to termination if the oil company doesn't continue to explore
Speaker 1: and develop. And so if I take a ten thousand
Speaker 1: acre lease in South Texas, each well I drill may
Speaker 1: be able to hold six acres, but once I stopped
Speaker 1: drilling wells to the extent there's undeveloped acres, I'm gonna
Speaker 1: lose that. That's going to go back to the mental owner.
Speaker 1: A lot of producers have have at this point now
Speaker 1: in in this phase of the shale revolution, most of
Speaker 1: the acreage that they have is held by production, meaning
Speaker 1: they're not subject to this continual drilling obligation. There are
Speaker 1: some people out there that if they don't drill, they're
Speaker 1: going to lose some acreage. And so those are the
Speaker 1: people that really faced with a tough decision. Do we
Speaker 1: spend money on a well that we know will not
Speaker 1: we're not going to get a profit on, but it
Speaker 1: holds our acreage versus do we just let the acreage go?
Speaker 1: And that is a decision that companies are having to
Speaker 1: make today. They're looking at that decision. In fact, we're
Speaker 1: we know of one company that is uh is deciding
Speaker 1: to or at least thinking they're going to let thousands
Speaker 1: of acres go because they don't want to be drilling
Speaker 1: in today's environment. But most producers, I think, after they've
Speaker 1: leaned on their service providers, after they've made some tough,
Speaker 1: tough decisions, are probably going to punker down. It's kind
Speaker 1: of what we've learned to do it. And he's periodically,
Speaker 1: when we get a hurricane come through, it's better not
Speaker 1: to leave town and and evacuate, but just to stay
Speaker 1: in place and let the storm, you know, blow over you.
Speaker 1: And then once the storm's gone, get back to work,
Speaker 1: and I think that's what you'll see this industry do.
Speaker 1: It's this is not the first uh curve ball to
Speaker 1: be thrown at the industry by any stretch. At the
Speaker 1: meat I mean, it's it's it's the nature of the business.
Speaker 1: This is a risk taking business, and people are prepared
Speaker 1: for the risk. There will be definitely some losers, but
Speaker 1: most people, I think will will adopt the hunker down
Speaker 1: mentality and try to see what direction the markets are
Speaker 1: going before they make any material decisions. So you're not
Speaker 1: betting on the Saluadias or the Russians are opec to
Speaker 1: deliver a death blow to domestic US energy any time too.
Speaker 1: I would I would never do that for any number
Speaker 1: of reasons, but not the least of which is I'm
Speaker 1: just kind of basically an optimist. Of course, one of
Speaker 1: my partners reminds me that back can I think it
Speaker 1: was in December. I was being interviewed and I was saying, Oh,
Speaker 1: this is not gonna be a major problem. It's gonna
Speaker 1: blow over. This is not a thing that we should
Speaker 1: worry about. Of Course, I could not have been more wrong.
Speaker 1: It was a major issue that happened in and this
Speaker 1: is another major issue, but I don't think it's the
Speaker 1: death knell for the oil industry. You mentioned this risk
Speaker 1: taking aspect of the oil industry, and I think that's
Speaker 1: what a lot of people associate with it. You know,
Speaker 1: people go out and try to find oil and some
Speaker 1: of them strike it rich and others don't. And historically
Speaker 1: that's been really attractive to bankers and other types of financiers.
Speaker 1: Can you talk to us a little bit about that process,
Speaker 1: especially in recent years. How did Wall Street and invest
Speaker 1: jurors and big financial institutions become so entangled with US
Speaker 1: shale well to to finance the shale revolution required a
Speaker 1: massive amount of capital, much more than had previously been
Speaker 1: invested in the industry back when they were drilling quote
Speaker 1: simple vertical wells on a one off basis. This shale
Speaker 1: revolution transformed the need for capital a hundredfold, and Wall Street,
Speaker 1: I think didn't see a lot of other attractive opportunities.
Speaker 1: This is coming off the financial crisis, and it was
Speaker 1: a great place to put money to to work with
Speaker 1: the quantitative easy A lot of money was available, it
Speaker 1: wasn't too expensive, and if you could get some great
Speaker 1: returns in the oil industry. Why why wouldn't you do it?
Speaker 1: The problem is once everybody invest in a deal, as
Speaker 1: you know, um, the return start to diminish significantly. And
Speaker 1: that that's been the results here. Because we invested in
Speaker 1: the US oil and gas industry. We were very successful.
Speaker 1: We were so successful that we've kind of shot ourselves
Speaker 1: in the foot by increasing production as much as we have,
Speaker 1: and we the supply is going to exceed demand. That's
Speaker 1: always gonna be a bad outcome for the supplier because
Speaker 1: prices are going to drop down until demand picks up
Speaker 1: or the supplies are reduced. What happened in call it
Speaker 1: that might have been the the golden air of the
Speaker 1: shale revolution. We were coming off that peak theory, peak
Speaker 1: oil theory that you know, that we're running out of
Speaker 1: oil that was being disproven. But there still was a
Speaker 1: great demand. You know, China was actively increasing their consumption.
Speaker 1: It really looked as if there was no end in
Speaker 1: sight for the golden Air. In fact, you mentioned the
Speaker 1: book that I wrote. I was writing it from through
Speaker 1: and about September October I was about ready to, you know,
Speaker 1: write the final chapter and say how great successful the
Speaker 1: oil industry is and how it's learned from all of
Speaker 1: its past mistakes and I will never make a mistake again.
Speaker 1: And then and then, and then Thanksgiving happened, and I
Speaker 1: had to spend another year digesting how wrong I was,
Speaker 1: and you know, summarizing the impact that that's had on
Speaker 1: the industry, and that I think we published the book
Speaker 1: in and obviously a lot has changed since then. But
Speaker 1: the main thing for oil producers, the smaller independence, is
Speaker 1: that the access to capital is becoming severely restricted, and
Speaker 1: that's going to really transform the industry. Is going to
Speaker 1: make the bigger players, the majors, the internationals, much more
Speaker 1: able to compete and get the good acreage, and the
Speaker 1: smaller independence are just gonna struggle because they without capital,
Speaker 1: they can't uh, they can't compete, they can't drill, they
Speaker 1: can't acquire, and they'll just have to wait until the
Speaker 1: markets sentiment on investing in the oil industry turns around
Speaker 1: and then they can have access to capital again. Well,
Speaker 1: I want to talk about that market sentiment towards oil
Speaker 1: because it's interesting. It feels like at any given moment,
Speaker 1: there's some overarching narrative that people will say, Okay, this
Speaker 1: is the new normal, And you mentioned the peak oil obsession.
Speaker 1: I remember that very well pre crisis. A lot of
Speaker 1: people really bought into that. Recently, even before the economy
Speaker 1: started turning down and uh the OPEC moves. There's just
Speaker 1: been a lot of pessimism about the future of oil.
Speaker 1: From the exact opposite point of view, people talking about
Speaker 1: electric vehicles and some sort of permanent decline of oil demand.
Speaker 1: That is just there's a secular shift away from oil period.
Speaker 1: It doesn't have anything to do with the economic cycle.
Speaker 1: Do you think that those forecasts are though that sentiment
Speaker 1: won't end up being as wrong as the peak oil
Speaker 1: sentiment was like in two thousand and seven two eight.
Speaker 1: That's a tough question, to be honest with you, and
Speaker 1: I wrestle with that a lot. I I think there
Speaker 1: is inevitably a transition with respect to certain uses for hydrocarbons,
Speaker 1: to renewable energy, to expand it. It can replace it
Speaker 1: or displace it. On balance, there's always going to be
Speaker 1: some need for hydrocarbons. The great quote by shake your
Speaker 1: money back in early two thousand that we didn't exit
Speaker 1: the stone age became because we ran out of stones.
Speaker 1: You know, we're not going to exit the hydrocarbon age
Speaker 1: because we run out of hydrocarbon. It's gonna be there's
Speaker 1: gonna be some better invention that just replaces the utility
Speaker 1: of of hydrocarbons. But right now there's so energy dense
Speaker 1: and so easy to store that as a transportation fuel,
Speaker 1: it really is unsurpassed. And obviously there's a lot of
Speaker 1: externality costs associated with it um and I think the
Speaker 1: industry is is addressing that. So predictions about the death
Speaker 1: of the oil industry, or hydrocarbon industry or are probably premature.
Speaker 1: It's a long transition period, but I think we are
Speaker 1: in the beginning of a transition period. So on the
Speaker 1: topic of evaluating the future price of oil, I wanted
Speaker 1: to dig into the redetermination process a little bit more
Speaker 1: if you could maybe walk us through how that works,
Speaker 1: what it means for shale companies, and anecdotally, I'd be
Speaker 1: really interested in hearing what kind of prices banks are
Speaker 1: using for redeterminations this season. I think the last time
Speaker 1: I spoke to you on this topic was back in
Speaker 1: two thousand fourteen, and they were using something like fifty
Speaker 1: dollars a barrel, and that was considered low back then.
Speaker 1: I imagine whatever they're using now is probably going to
Speaker 1: be even lower. Yeah, and that that's a there's a
Speaker 1: lot in that question to unpack. But just to answer
Speaker 1: that last question first, right now, the banks are are
Speaker 1: resetting their price decks, which is the basis upon which
Speaker 1: they determine how much they're willing to land against a
Speaker 1: producers oil and gas assets. And we uh paid the
Speaker 1: moon last fall sent out emails to about twenty five
Speaker 1: of the energy bankers, mostly here in Houston, and that's
Speaker 1: probably a good sampling of the universe, if not the
Speaker 1: entirety of the universe, for what their price decks were.
Speaker 1: We did that again two weeks ago to twenty five
Speaker 1: banks and we've already gotten some responses before Friday of
Speaker 1: last week, but as of the price collapse over the weekend,
Speaker 1: we we sent out a new request to all the
Speaker 1: same banks and saying, if you're going to redetermine your
Speaker 1: price dex, let us know so we can include the
Speaker 1: more current information and the initial responses we got back
Speaker 1: from a lot of the bankers where yeah, hold off,
Speaker 1: we're we're still looking at that, but we're gonna come
Speaker 1: up with the new price dex. So I guess stay
Speaker 1: tuned on what the price deck will be. But to
Speaker 1: back up your question originally, is how is our barring
Speaker 1: bases determined? And just on the most fundamental level, an
Speaker 1: oil and gas producer borrowing money from a commercial bank
Speaker 1: is UH. It's an asset based loan. But it's a
Speaker 1: unique asset based loan because most assets are inventory, floor inventory,
Speaker 1: or something that's out there and it doesn't disappear overnight.
Speaker 1: It doesn't lose value necessarily UH, And so those asset
Speaker 1: based loans are done in a different formula, but nevertheless
Speaker 1: it's a borrowing based formula. The reason why only gas
Speaker 1: is different is because the oil and gas is continually
Speaker 1: being produced and depleting, and producers are drilling more wells
Speaker 1: and replacing those reserves and so has As that cycle
Speaker 1: goes through the company's production inventory, the banks will reevaluate
Speaker 1: not only the total amount of recoverable reserves, but also
Speaker 1: what value the producers expected to receive for those reserves
Speaker 1: over the life of the loan, usually over a three
Speaker 1: to five year period, so every six months. Because that
Speaker 1: collateral value fluctuates, the industry has come up with a
Speaker 1: formula that every six months banks will relook at the
Speaker 1: producers asset base and say how much they'll be willing
Speaker 1: to loan against it. That number historically goes up, both
Speaker 1: because prices historically go up and producers continue to develop
Speaker 1: and acquire and drill and increase the total number of
Speaker 1: reserves they have. However, h what goes up can come down,
Speaker 1: and producers are going to find that probably a lot
Speaker 1: of the barring bases across the board at best will
Speaker 1: be held steady, but more likely will fall down. There
Speaker 1: their mitigants again us that a lot of producers, in
Speaker 1: large part because the banks required have hedged their production
Speaker 1: and so they have locked in prices on the near
Speaker 1: term for the next twelve to thirty six months. And
Speaker 1: if they put those hedges on in January seventh, whenever
Speaker 1: that the Iran issue arose, they might they might have
Speaker 1: sixty hedges on their books for the next twelve months.
Speaker 1: Those guys are feeling pretty smart. Other people may have said,
Speaker 1: I don't want to hedge at sixty, I want to
Speaker 1: wait ti Ut seventy five, and those people are our
Speaker 1: kicking themselves. But what the banks do not only looking
Speaker 1: at current market prices, They're also going to look at
Speaker 1: what hedgebook does the producer have, because that could support
Speaker 1: a higher barring base. So not everybody's going to see
Speaker 1: a barring based reduction, but probably on ballast they will. Right.
Speaker 1: So this might be a stupid or naive question, but
Speaker 1: why is there a season? Why is there a set
Speaker 1: time when this all happens at once, as opposed to
Speaker 1: this just being an ongoing, continuing process by the capital
Speaker 1: markets or by the banks to always be uh in
Speaker 1: the state of permanent uh evaluating their clients, their borrowers.
Speaker 1: I mean, that's a that's a good question, and in fact,
Speaker 1: banks have the opportunity as well as borrowers if they
Speaker 1: think they're they're collateral worth of you know, twice three
Speaker 1: times where they're getting the barring base. They have what
Speaker 1: we call a wild card election between each six month
Speaker 1: reree determination period to say I want you to re
Speaker 1: evaluate my reserves. So the banks say, hey, we're going
Speaker 1: to reevaluate your reserves, and we you know, usually aren't
Speaker 1: gonna do that, but it's where they're going to reduce
Speaker 1: the value. They do it every six months because it's
Speaker 1: a process. You have to go out and engineer the wells,
Speaker 1: update your engineering, add new wells that have been drilled, etcetera.
Speaker 1: So it's it's not something that you kind of just
Speaker 1: you know, check your your monitor every morning to see
Speaker 1: what your reserve base barring base is once every year.
Speaker 1: It's done by a third part, any resure engineering firm,
Speaker 1: and so that's that's a cost, I don't know, fifty
Speaker 1: hundred fifty thousand dollars. So you don't want to just
Speaker 1: incurr that cost every day to get comfort on what
Speaker 1: your barring bases. And from the bank's perspective, the banks
Speaker 1: are not giving a barring base equal to exactly what
Speaker 1: the reserves are that day. The banks are going to
Speaker 1: discount the barring base to be st of the present
Speaker 1: value of the future expected production from the wells over
Speaker 1: the life of their production. So there's there's lots of
Speaker 1: cushion in a barring base that is intended for the
Speaker 1: banks to be protected. On the downside, because the banks,
Speaker 1: the banks are not really getting rewarded much for making loans.
Speaker 1: They're getting you know, base rate plus two or live
Speaker 1: war plus one fifty, So there's no real reward for
Speaker 1: the banks to be super risky and and therefore these
Speaker 1: barring bases while they're set just twice a year. They're
Speaker 1: staying with a lot of cushion, and there is this
Speaker 1: call it wild card option for either the bank or
Speaker 1: the bar words to trigger during a six month period
Speaker 1: if they take the barring bases off. But I wanted
Speaker 1: to ask you about the mix of financing for US
Speaker 1: shale as well, because clearly we've just been talking about
Speaker 1: the sort of reserved based bank loans UM, but shale
Speaker 1: companies also issue bonds and they can also take out
Speaker 1: second lean loans if they need to. How does that
Speaker 1: dynamic or that mix of funding um end up impacting
Speaker 1: actual appetite for shale exposure. Well, I would say the
Speaker 1: options are dwindling for producers to access capital. The traditional
Speaker 1: commercial bank loans are there, but bankers are not aggressively
Speaker 1: competing against one another to increase their more or could
Speaker 1: share in this industry, and so new new loans are
Speaker 1: very few and far between a month. Commercial banking sides
Speaker 1: the second clean loan market, which was very robust in
Speaker 1: the golden air of the shell plays, there are still
Speaker 1: some second leans, but now it's not so much because
Speaker 1: producers are needing to grow faster. It's because producers are
Speaker 1: needing capital to survive, and the second leane market is
Speaker 1: significantly smaller and much more expensive. The bond market is
Speaker 1: for all intense purposes gone, and that's a that's a
Speaker 1: major story for producers that are facing bond maturities in
Speaker 1: if they're unable to refinance their bonds in the next
Speaker 1: twelve months, there really is no alternative for them but
Speaker 1: to do either out of court or through bankruptcy exchange
Speaker 1: of the debt for equity. And that's that's a real
Speaker 1: problem for those producers that are publicly reporting on bond debt.
Speaker 1: And then the fourth avenue of access for capital, traditional
Speaker 1: capital is the stock market, and I think the stock
Speaker 1: market spoke pretty loudly yesterday about how enthusiastically are upholding
Speaker 1: equities and exploration and production companies. So what we're seeing
Speaker 1: now are structured finance loans that are made with For example,
Speaker 1: a deal we just closed last week, it has a
Speaker 1: ten year hedge. That's pretty much unheard of because basically
Speaker 1: there's not a lot of market ten years out. But
Speaker 1: in order to get the capital this producer to finance
Speaker 1: an acquisition was willing to lock in prices for ten years.
Speaker 1: The counterparty on the hedge side was willing to do
Speaker 1: the same thing. And that's a pretty unique structure. Question
Speaker 1: whether or not that becomes the new the new norm.
Speaker 1: We also saw another kind of structure which is called
Speaker 1: a drill code, which is a I don't want to
Speaker 1: get too deep in the weeds on that, but it's
Speaker 1: it's basically a financial farm out that independent producers used
Speaker 1: to use in the nineteen thirties, forties and fifties, but
Speaker 1: now instead of a farm out from an oil company,
Speaker 1: they're getting a farm out from private equity capital company.
Speaker 1: You know, any time you say you can't do X,
Speaker 1: somebody in the oil industry is going to figure out
Speaker 1: a way to get around it. And if the markets
Speaker 1: are telling oil companies we're not going to give you
Speaker 1: any more money, I will guarantee the oil companies will
Speaker 1: figure out somebody who will and it may be a
Speaker 1: structure that may not be as attractive, but it will
Speaker 1: be a structure that will work. And capital just has
Speaker 1: a way of finding itself to the producers. You know,
Speaker 1: it's not gonna be so much dumb money that you
Speaker 1: might have seen when everybody is jumping in on the bandwagon.
Speaker 1: It's going to be smarter money, be more expend to
Speaker 1: be more structured. But if you have the right project,
Speaker 1: you have the right rocks, as they say you can,
Speaker 1: you can find the money to drill them. When you
Speaker 1: talk about the when you talk about that ten year
Speaker 1: hedge and you said you know there's not much market
Speaker 1: tenures out, is that essentially the oil company agreeing to
Speaker 1: sacrifice theoretical potential upside in the price of oil, and
Speaker 1: then the lender capturing that upside if we get if
Speaker 1: we were to see a major rebounding price. Yeah, although
Speaker 1: in that's instance, the counterparty to the hedge is the
Speaker 1: one who potentially gets the upside, and the producer is
Speaker 1: definitely giving up upside by locking in a price today.
Speaker 1: But if it guarantees the acquisition and the reserves are
Speaker 1: gonna continue to produce well after the hedges roll off,
Speaker 1: then they're probably okay with that. Plus in in in
Speaker 1: the real world, you know, to or three years from now,
Speaker 1: if the market turns around, they may unline that whole
Speaker 1: transaction and put in some more conventional financing on it.
Speaker 1: Just because you locked in a ten year deal doesn't
Speaker 1: mean you actually wait the entire ten years and pay
Speaker 1: it back. There's there's ways to refinance it if and
Speaker 1: when it becomes the right decision to do or refinance
Speaker 1: if if things get bad enough for the shale industry,
Speaker 1: would you expect some sort of support measure from either
Speaker 1: the local state governments or the federal government. Given that,
Speaker 1: you know, it's now a bigger part of the U.
Speaker 1: S economy, it's a big employer for a lot of people.
Speaker 1: Do you think that's a possibility. Um, I really don't.
Speaker 1: I think that the industry by and large has been
Speaker 1: able to, you know, handle these ups and downs. Obviously
Speaker 1: there's going to be bankruptcies, uh, and there will be,
Speaker 1: so the ownership of these companies may change, But ultimately
Speaker 1: the hydrocar vans will still be underground. The oil and
Speaker 1: gas is not going anywhere. It's been there for a
Speaker 1: million years, so it will still be accessible provided somebody
Speaker 1: has the capital to drill and produce it. I don't
Speaker 1: think that there would be much appetite in any sense,
Speaker 1: except for maybe in Oklahoma and Texas congressman to even
Speaker 1: float that idea, But but it would be shot down
Speaker 1: by the rest of the country. So I don't think
Speaker 1: our oil and gas producers are looking for any type
Speaker 1: of bailout from the federal government to solve the problems. Buddy,
Speaker 1: that was really great. Thank you so much for coming on.
Speaker 1: That was awesome. Happy to do it, Happy to do it.
Speaker 1: I hope, I hope my predictions about the industry surviving
Speaker 1: are are accurate enough. And and I also hope that
Speaker 1: this current period is the challenging period that we're faced with,
Speaker 1: is does not last for too long and we figure
Speaker 1: out some answers to it, because, frankly, as I think
Speaker 1: you all know, the oil industry and what it's done
Speaker 1: for the US economy has been phenomenal, and we don't
Speaker 1: want to we don't want to lose the momentum that
Speaker 1: we've built up with that, all right, thank you, buddy.
Speaker 1: So Joe, I really love that conversation, Uh, first of all,
Speaker 1: because it brings up a lot of memories of similar
Speaker 1: things that we're happening in two thousand, two thousand and fifteen,
Speaker 1: which I found really interesting then. But also this nexus
Speaker 1: between capital being funneled by Wall Street and financial institutions
Speaker 1: and how it sort of enters the shale industry, I've
Speaker 1: just always found really fascinating. Yeah, you've been covering this
Speaker 1: angle for a long time, and I did think it
Speaker 1: was fascinating hearing him talk about, uh, you know, the
Speaker 1: degree to which this show revolution is simultaneously a technology
Speaker 1: story and a capital market story, and hearing them talk
Speaker 1: and hearing you talk absolutely about the degree to which
Speaker 1: these companies were able to innovate so fast in terms
Speaker 1: of cutting costs after Thanksgiving. But also even with that,
Speaker 1: you know this sort of this ten year expansion or
Speaker 1: eleven year expansion that may be coming to an end
Speaker 1: of risk capital. Basically that that combination really just sort
Speaker 1: of of those two things at the same time really
Speaker 1: just changing the entire complexion of the world or the
Speaker 1: world's energy industry. Yeah. Absolutely, And also the market response
Speaker 1: is just going to be fascinating to see that play out, because,
Speaker 1: as Buddy was describing, there's such a mix of financing
Speaker 1: options for shale companies at the moment, and each one
Speaker 1: of those financing options impacts the other. So you know,
Speaker 1: if you take out a second lean loan, you're probably
Speaker 1: pushing your bond hole is further down the capital structures,
Speaker 1: so maybe bond holders don't want to invest in you anymore.
Speaker 1: It's it's a really interesting and complex dynamic, and when
Speaker 1: you add a thirty price drop and Crewe to that mix,
Speaker 1: it becomes even more interesting. Yeah. I really like hearing
Speaker 1: them talk about the actual details of I mean the
Speaker 1: whole reason we have the discussion because it's the time
Speaker 1: again for banks to determine their borrowing base, but just
Speaker 1: the discussion of how they go about that, because I
Speaker 1: do think it's very easy to abstract away from that
Speaker 1: and say, Okay, oil prices are down and bond yields
Speaker 1: on junk energy debt are up, and that's bad and
Speaker 1: so forth. But then thinking about the different ways that
Speaker 1: still companies can hang on and survive, and you know,
Speaker 1: I like the whole like the Texas grit of always
Speaker 1: of finding a way either through technology or new capital structures,
Speaker 1: even with all these body blows. Yeah, Texas grit. It's
Speaker 1: that innovation and also the rejection in of federal support
Speaker 1: as well. I feel comfortable saying that because my dad's
Speaker 1: from Texas and I lived in Dallas, so I get
Speaker 1: to say that. Um, okay, Well, this has been another
Speaker 1: episode of the All Thoughts podcast. I'm Tracy Allaway. You
Speaker 1: can follow me on Twitter at Tracy Alloway, and I'm Joe.
Speaker 1: Why isn't though? You can follow me on Twitter at
Speaker 1: the Stalwart, and you should follow our producer on Twitter,
Speaker 1: Laura Carlson. She's at Laura M. Carlson. You should follow
Speaker 1: the Bloomberg head of podcast on Twitter, Francesca Levi at
Speaker 1: Francesca Today, as well as all the Bloomberg podcasts under
Speaker 1: the handle AD Podcasts. Thanks for listening one