Export Development Canada announced on Friday that it will guarantee loans of up to $100-million by banks to junior energy companies.Justin Tang/The Globe and Mail
A new federal program to backstop loans to small and mid-sized energy companies could cut the number of producers that fall into bankruptcy in the coming months as oil prices hit record lows, according to executives and analysts.
Export Development Canada announced on Friday that it will guarantee loans of up to $100-million by banks to junior energy companies, in the hopes of preventing lenders from slashing credit lines and thereby forcing small companies to breach their loan covenants.
“It seems like a pretty common sense way to prevent a whole lot of E&P [exploration and production] companies from being offside with their lenders," said Jim Evaskevich, chief executive of Yangarra Resources, a Calgary-based exploration and development company.
Small and mid-sized upstream energy companies are particularly vulnerable to sudden price shocks, because they rely on lines of credit secured against their undeveloped oil and gas reserves. As prices drop, the value of the reserves decline, causing banks to trim their lines of credit.
Reserve-based loans are reassessed twice a year, typically in May and November. As such, energy companies were expecting significant cuts to their credit lines next month as banks adjusted their borrowing base calculations to reflect a drop in the value of their reserves.
“Say you owe $100-million, and you had good coverage going into this. But now, because of the pricing they apply to your reserves, you’re only good for $75-million. Well, at that point everybody has got a problem," Mr. Evaskevich said.
The EDC program is meant to encourage banks to maintain the “borrowing base" for credit lines, in spite of price readjustments, by guaranteeing up to $100-million of their loans.
“This will give banks a lot more comfort to lend money, as opposed to what was likely shaping up to be a pretty ugly spring bank line re-determination," said Jeremy McCrea, an analyst at Raymond James.
“If you had a $250-million bank line at year-end, and under the updated strip prices that goes to $125-million, well, the EDC will backstop a $100 million above that $125, so you basically go back up to $225," he explained.
There are caveats to the program, which was announced alongside $1.7-billion from the federal government to clean up orphan wells, as well as additional loans for energy companies from the Business Development Bank of Canada.
Only companies that produce less than 100,000 barrels a day are eligible for EDC’s loan coverage. Moreover, borrowers need to have had a “reasonable pre-crisis leverage or rating." In other words, the EDC is not positioned to save companies that were on the verge of bankruptcy before oil prices were driven down by the COVID-19 pandemic and a dispute between Saudi Arabia and Russia.
While the program is welcome, details remain hazy, said Neil Korchinski, CEO of Petrus Resources Inc., a Calgary-based oil and gas junior. It’s also unclear, he said, whether the program is designed primarily to help energy companies or to provide respite to lenders stuck with rapidly deteriorating energy loan books.
Banks don’t want to tip energy companies into bankruptcy, Mr. Korchinski said, as the traditional methods for enforcing on loans have become less effective in recent years.
“Even before the Saudi price wars and COVID issue, we were in an extremely equity- and debt-constrained market,” he said.
“The ability to sell assets was non-existent five months ago. Now that the pricing is even worse, it’s like, ‘I tripped you into default, but what’s my recourse as a bank?’ There is none. The classic response would be, ‘You need to issue some equity, or you need to sell some assets.’ Both of those are impossible right now," Mr. Korchinski said.
Robert Fitzmartyn, head of Energy Institutional Research at STIFEL FirstEnergy, said the program is designed, first and foremost, to help banks manage their loan books.
“Banks can effectively allocate these notional funds as they see fit; so the government backstop goes to the weaker parts of debt, and they continue to service companies they see existing past this chasm," he said.
For hard-hit energy producers, the trying circumstances will remain largely the same, he said. “It staves off bankruptcy, but is there going to be any lift in employment numbers or anything off of this? No."
Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.