If you're one of the millions of Americans suddenly underwater on your mortgage, then you can certainly relate to the pain being inflicted by borrowing base redeterminations on small oil and gas companies today.
Small-cap exploration and production companies (E&Ps), unable to tap the debt market as easily as a hulk like XTO Energy
Breaking the piggy bank
Like many homeowners, E&Ps lived beyond their means over the past few years, and their capital budgets routinely exceeded operating cash flows. Bank borrowings helped to cover the cash flow gap. Now, aside from challenging economics, a major motivation for E&Ps to dramatically cut their capex in 2009 is to free up cash flow to pay down these bank lines and increase liquidity.
Borrowing base redeterminations makes the situation doubly dire for some overleveraged outfits. As you may have guessed from the name, this is a periodic (often semi-annual) exercise in which the banks take a fresh look at the E&P's reserves and future expected commodity prices and make adjustments to the borrowing base if necessary.
In good times, E&Ps are usually able to ratchet their borrowing bases higher. EOG Resources
Who's playing with fire
For a company like McMoRan Exploration, which had an undrawn facility at year-end, the fact that the company expects a lower borrowing base coming out of its April redetermination isn't too serious. For PetroQuest
Some companies that are pretty heavily drawn on their bank revolvers have so far dodged a bullet. Mariner Energy
Some companies are coming out of this process unscathed. Range Resources not only maintained its borrowing base, but avoided the fee and interest rate hikes hitting Mariner. Given its low-cost production and cash flow hedges, I feel fine about Range, despite its roughly 65% drawdown as of February. I'm even more comfortable with Southwestern Energy
The Foolish bottom line
While redeterminations can spell havoc for overleveraged firms, they also open an opportunity for well-financed outfits. In order to stay on side of borrowing limits and financial covenants, distressed E&Ps are going to start putting a lot of properties on the market over the next few months. That fire sale to Chesapeake Energy