Equity and Debt Financing for Existing Oil and Gas Production – A Hot Topic!
The question is: To use equity or debt or a combination of the two? This question has the potential to bring a couple of oil and gas people to a fist-a-cuffs. People are that passionate about the topic.
Old timer E&P folks who weathered the 1983 downturn tend to be the most cautious. They remember the days when oil and gas companies went from owning private jets to liquidating everything. Many who made it through that painful period decided they would never owe a bank again.
Determining a strategy on how to use equity and debt to finance existing oil and gas production is critical for the success of a small E&P company.
Then there are the folks that saw the price of oil go to $100 a Bbl. Who decided to borrow large sums of money against existing production to drill more wells to create more production and more profits.
Many of those companies using that strategy haven’t fared well. Oil and gas firms used senior debt borrowed from banks like Bank of Oklahoma and other banks like Bank of America, Wells Fargo, and J.P. Morgan Chase.
According to Haynes and Boone, LLP, a law firm that has a significant oil and gas practice, 90 oil companies have filed bankruptcy between January 1, 2015, and August 1, 2016.
Clearly, too much debt is bad, but can there be some balance between equity and debt financing of oil and gas production financing?
The Pros and Cons of an Equity Only Approach
If too much debt can sink an oil and gas exploration company, then can too much equity be bad also?
An equity only approach to financing oil and gas production primarily means the company is debt free. As the saying goes, he who provides the cash gets to make the rules and often gets to control the enterprise. Growing rapidly and keeping more in founders’ pockets means using some senior or mezzanine debt.
Using equity only is the safest approach for financing a company in a cyclical industry, but it can make it hard to grow while keeping a bigger piece of the pie.
Mixing Equity and Debt – A Reasonable Compromise?
Some successful companies have found having a mixture of equity and debt is a good middle ground. Whether their safe ratio is 60% equity / 40% debt or higher, they have balanced their downside risk while keeping a bigger share of the enterprise.
Senior or subordinated debt lenders offer lower rates when a company is not highly leveraged. At the same time, equity shareholders get to see a higher yield on their investments because of adding a reasonable amount of debt.
This approach is least risky when the price of a commodity like WTI is at or near the bottom of its price range.
Business Finance Solutions has an answer to your oil and gas production financing needs whether you want to use straight equity, senior or subordinated debt, or a combination of both.
Call us for more information! 512.990.8756.