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Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast.

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Speaker 1: I'm Tracy Allaway and I'm so Joe. We have seen

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Speaker 1: an absolutely stunning drop in the price of oil. Uh,

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Speaker 1: that is, to put it mildly, I would say the

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Speaker 1: stunning drop, I mean stunning, stunning is mild. You know,

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Speaker 1: oil had already been precipitously declining all year mid concerns

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Speaker 1: about economic growth and supply, and then of course over

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Speaker 1: the weekend Saudi Arabia just came out and shocked the world. Yeah,

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Speaker 1: so Saudi Arabia basically said it wasn't going to extend

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Speaker 1: the production cut agreement that had kind of provided a

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Speaker 1: floor for oil prices for a few years. Now. Oil

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Speaker 1: promptly fell something like over the weekend, which was the

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Speaker 1: biggest fall since the First Gulf War, and it's recovered

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Speaker 1: a bit since then. At the time of our recording,

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Speaker 1: I think Brent, the global benchmark for cruit is trading

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Speaker 1: at thirty seven dollars a barrel, and w t I

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Speaker 1: in the U S is at thirty three dollars a barrel.

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Speaker 1: But it is still massively bad news for the U

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Speaker 1: S energy sector. Yeah, absolutely right. When oil opened and

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Speaker 1: so just so that people understand the timing. Obviously we're

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Speaker 1: recording this Tuesday, March tenth. But when oil opened this

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Speaker 1: past Sunday and everyone was watching with their jaws on

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Speaker 1: the floor at that crash, the only thing that I

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Speaker 1: sort of that it reminded me of at the time

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Speaker 1: is like when bear Stearns opened to two dollars to share.

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Speaker 1: It was that, like it was just that much of

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Speaker 1: a dislocation that I can't think of anything else sort

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Speaker 1: of comparable in the last Okay, seeing that move, Yeah,

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Speaker 1: a huge dislocation in the market, a big surprise for

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Speaker 1: OPEC watchers. But all of that is sort of bad

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Speaker 1: enough for the energy patch. But there's something that makes

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Speaker 1: it even more painful if you can believe it, which

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Speaker 1: is that this is coming, this oil price drop is

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Speaker 1: coming at a very special time in the energy market.

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Speaker 1: Right around this time of the year, we have something

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Speaker 1: known as the borrowing base redetermination process or season, which

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Speaker 1: is basically the time in which banks reassess their loans

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Speaker 1: to energy companies. So those loans are based on an

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Speaker 1: estimate of the value of their oil and energy related assets.

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Speaker 1: So the fact that they're going to be doing this

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Speaker 1: right after oil fell is really not good, right, It's

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Speaker 1: terrible timing because a as you mentioned, oil is getting clubbed,

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Speaker 1: and then on top of every thing, because of the

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Speaker 1: volatility and financial market, there is not a particularly high

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Speaker 1: amount of risk appetite to fund anything, let alone extremely

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Speaker 1: risky energy players who's uh suck the commodity that they

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Speaker 1: sell just player a day. Absolutely, and the interplay between

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Speaker 1: the U S energy sector and capital markets is a

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Speaker 1: really interesting one. So we're going to dive into it

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Speaker 1: on this episode. We're going to get maybe a little wonky,

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Speaker 1: but it'll be fun. Our guest for this episode is

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Speaker 1: Buddy Clark. He's a partner at the law firm Haynes

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Speaker 1: Boone based over in Houston. He's also the author of

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Speaker 1: Oil Capital, The History of American Oil, Wildcatters, Independence and

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Speaker 1: their Bankers, which is basically all about the relationship between

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Speaker 1: energy and capital and banking. So he's really the perfect

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Speaker 1: person to discuss this. Buddy, thanks so much for coming on.

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Speaker 1: Thank you for u inviting me so Buddy, I mentioned

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Speaker 1: that you're based out in Houston. Joe mentioned the massive

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Speaker 1: reaction to the oil price fall over the weekend. What

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Speaker 1: reaction did you see out in the oil patch in

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Speaker 1: Texas well, I think everybody's seeing a little bit of

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Speaker 1: shell shock at the moment and waiting to see where

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Speaker 1: the prices settle out. Obviously, it's been a major drop

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Speaker 1: in prices and that's significant for producers all up and

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Speaker 1: down the value chain as far as their size and

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Speaker 1: debt leverage ratios. But I think right now people are

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Speaker 1: still hold their breath to sea where that's going to

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Speaker 1: fall out. You know, you saw a couple of the

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Speaker 1: larger independence announced they were just gonna cut back significantly

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Speaker 1: on drilling capital expenditures, and that's probably going to be

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Speaker 1: the theme coming out for the next couple of weeks

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Speaker 1: from all the publicly recording companies. Well, there's a lot

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Speaker 1: of a lot of different moving parts here. Obviously, the

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Speaker 1: move from Saudi Arabia Carrington, the reporting was precipitated by

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Speaker 1: tension between Saudi Arabia and Russia. I think are the

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Speaker 1: report called it Saudi Arabia firing a shot in the

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Speaker 1: oil price war. But talk to us about the OPEC

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Speaker 1: politics as it relates to their desire to see carnage

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Speaker 1: within U u s domestic energy, which of course is

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Speaker 1: as everyone is noted, has made OPEC or OPEC plus

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Speaker 1: less of an important entity than it used to be

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Speaker 1: in sending the global price. Well, I guess historically we've

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Speaker 1: seen OPEC do this at least three times, in the

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Speaker 1: mid eighties and Thanksgiving and now again. Uh it's I

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Speaker 1: wouldn't ascribe malintent by OPEC. Are the Saudis to put

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Speaker 1: all the U s producers out of business? It's just

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Speaker 1: their goal to maintain their market share, and if that

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Speaker 1: means they're losers out there, then that's just the way

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Speaker 1: capitalism and the oil markets work. But I think clearly

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Speaker 1: it has been the revolution of the US producers in

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Speaker 1: the shale field that has triggered this massive influx of production,

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Speaker 1: dramatic increase in US deliverability, and made the US number

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Speaker 1: one exporter of oil. That's obviously gotten the attention to

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Speaker 1: the Saudis and Russia as well. Um So, the goal

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Speaker 1: that OPEC had in the eighties and again in was

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Speaker 1: just we're tired of giving up our market share the

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Speaker 1: profit oil prices for the benefit of other producers. And

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Speaker 1: they've gotten to that point again because I suspect the

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Speaker 1: Russians did not want to continue to subsidize, not necessarily subsidize,

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Speaker 1: but but provide a floor for US producers to continue

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Speaker 1: to produce. And we'll have to now see how this

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Speaker 1: all plays out in the next couple of weeks or months.

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Speaker 1: Hopefully won't be in the next couple of years, but

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Speaker 1: there's really no way of knowing right now what the

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Speaker 1: implications are, right. So, I was looking at one set

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Speaker 1: of estimates earlier today which said the oil in the

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Speaker 1: low thirty dollars a barrel basically means that almost all

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Speaker 1: of US shale is now unprofitable. Uh, That particular forecast

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Speaker 1: said only five companies in two areas of the country

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Speaker 1: now have break even costs that are lower than the

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Speaker 1: current oil price. What's your sense of the break even

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Speaker 1: rate of US shale because there's a lot of debate

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Speaker 1: on this topic. Yeah, and there's a lot of different

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Speaker 1: metrics one can use. If you're talking about what is

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Speaker 1: the cost to go out and acquire the land and

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Speaker 1: to drill and complete and to bring onto production a

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Speaker 1: well that numbers can be a whole lot higher than

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Speaker 1: those producers that have current wells that are producing. How

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Speaker 1: much does it cost them in the field just to

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Speaker 1: continue to get the production out of the ground. Uh.

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Speaker 1: I think the least operating expense for existing production wells

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Speaker 1: that are currently online. I think that cost is lower

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Speaker 1: than thirty dollars to barrel. So it's not like producers

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Speaker 1: are shutting in wealth because they can't recover their cost

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Speaker 1: of producing, but the ability of the producers to actually

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Speaker 1: go out and drill wells, even on lands of that say,

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Speaker 1: they've already sunk the cost on land acquisition and now

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Speaker 1: it's just the drilling completion cost. Those are that capex

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Speaker 1: is going to be cut back. That's what diving Back

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Speaker 1: said they were going to do. A number of other

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Speaker 1: producers are are starting to pull back from their drilling plans.

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Speaker 1: And in that number various I guess, from basin to basin.

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Speaker 1: But the lowest I heard was of barrels. So if

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Speaker 1: prices they are below forty five over a long term,

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Speaker 1: over you know, the predicted life of the wells production,

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Speaker 1: then if you can't you can't recover that cost, you're

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Speaker 1: not going to drill the ells. How does that compare

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Speaker 1: either the costs of new drilling of wells or the

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Speaker 1: cost structure of existing wells that are already uh pulling

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Speaker 1: oil out? How much of costs come down you mentioned,

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Speaker 1: I think Thanksgiving or was when the last time we

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Speaker 1: saw such a dramatic move. Are the domestic players leaner?

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Speaker 1: Have they got their cost structures more competitive since that time? Yeah,

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Speaker 1: that's that's a great question. That's I think one of

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Speaker 1: the uh number of ways that OPEC underestimated the impact

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Speaker 1: of their Thanksgiving price drop. They assumed that producers costs

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Speaker 1: were static and that the technology was static. But in fact,

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Speaker 1: uh necessity being the mother of invention, the producers in

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Speaker 1: the US kind of took it in stride. They were

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Speaker 1: probably a lot more overweight back in coming off of

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Speaker 1: barrel price just a few years before that it was

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Speaker 1: still a hundred dollars of barrel and there about that summer,

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Speaker 1: so producers had a lot of fluff, let's say, in

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Speaker 1: their overhead and the way they were doing business. But

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Speaker 1: when the price was crammed down, the producers adjusted and

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Speaker 1: adjusted quickly. And not only did they lean on the

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Speaker 1: drillers and and other oil field service providers to cut

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Speaker 1: their cost, but they found ways to maximize their drilling efficiency.

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Speaker 1: Instead of drilling one horizontal well per drill pad, they

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Speaker 1: you know, developed a six well pad drilling with drilling

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Speaker 1: rigs that they wouldn't have to move by by dozers.

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Speaker 1: They just have caterpillars on the drilling rigs, and the

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Speaker 1: drilling riggs themselves were mobile. And the way where they

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Speaker 1: were able to get cost down considerably in order to

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Speaker 1: adjust to the new world prices. What about now? What about?

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Speaker 1: Have we already discovered or invented all the cost saving

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Speaker 1: measures that are possible to invent? And I would say

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Speaker 1: that the past would be predictive. There's more and there's

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Speaker 1: more ways to invent in the oil field industry than

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Speaker 1: you can imagine. And and there are people right now

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Speaker 1: thinking of ways how do we cut costs on drilling,

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Speaker 1: how do we cut costs on completion, etcetera. So, while

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Speaker 1: there's not as much bluff, I don't think the industry

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Speaker 1: is going to raise a white flag and say we're

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Speaker 1: you know, we're not going to compete anymore. They're they're

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Speaker 1: going to be looking for ways to cut costs and

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Speaker 1: to compete in global markets. Yeah. I remember back in

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Speaker 1: two thousand and fifteen doing a story on this, and

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Speaker 1: some of the energy companies were really creative in cutting costs,

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Speaker 1: like even switching light bulbs and standardizing the nuts and

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Speaker 1: bolts they were using, like actually getting down to the

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Speaker 1: nuts and bolts of their operation in order to save costs.

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Speaker 1: It was pretty amazing. Just on that note, what's the

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Speaker 1: easiest way for an energy company to try to ride

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Speaker 1: out the current route in oil? I imagine cost cutting

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Speaker 1: is one of them. Cutting back on investment is another

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Speaker 1: obvious choice. But what's the sort of easiest for knee

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Speaker 1: jerk reaction that you would expect most firms to have here? Well, um,

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Speaker 1: Historically the first reaction is to lean on their provide

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Speaker 1: their service providers, UH, and to cut back on expenditures

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Speaker 1: they don't need to make. For your audience is not

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Speaker 1: fully aware of this, Oil and gas leases are subject

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Speaker 1: to termination if the oil company doesn't continue to explore

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Speaker 1: and develop. And so if I take a ten thousand

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Speaker 1: acre lease in South Texas, each well I drill may

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Speaker 1: be able to hold six acres, but once I stopped

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Speaker 1: drilling wells to the extent there's undeveloped acres, I'm gonna

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Speaker 1: lose that. That's going to go back to the mental owner.

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Speaker 1: A lot of producers have have at this point now

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Speaker 1: in in this phase of the shale revolution, most of

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Speaker 1: the acreage that they have is held by production, meaning

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Speaker 1: they're not subject to this continual drilling obligation. There are

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Speaker 1: some people out there that if they don't drill, they're

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Speaker 1: going to lose some acreage. And so those are the

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Speaker 1: people that really faced with a tough decision. Do we

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Speaker 1: spend money on a well that we know will not

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Speaker 1: we're not going to get a profit on, but it

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Speaker 1: holds our acreage versus do we just let the acreage go?

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Speaker 1: And that is a decision that companies are having to

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Speaker 1: make today. They're looking at that decision. In fact, we're

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Speaker 1: we know of one company that is uh is deciding

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Speaker 1: to or at least thinking they're going to let thousands

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Speaker 1: of acres go because they don't want to be drilling

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Speaker 1: in today's environment. But most producers, I think, after they've

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Speaker 1: leaned on their service providers, after they've made some tough,

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Speaker 1: tough decisions, are probably going to punker down. It's kind

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Speaker 1: of what we've learned to do it. And he's periodically,

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Speaker 1: when we get a hurricane come through, it's better not

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Speaker 1: to leave town and and evacuate, but just to stay

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Speaker 1: in place and let the storm, you know, blow over you.

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Speaker 1: And then once the storm's gone, get back to work,

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Speaker 1: and I think that's what you'll see this industry do.

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Speaker 1: It's this is not the first uh curve ball to

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Speaker 1: be thrown at the industry by any stretch. At the

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Speaker 1: meat I mean, it's it's it's the nature of the business.

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Speaker 1: This is a risk taking business, and people are prepared

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Speaker 1: for the risk. There will be definitely some losers, but

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Speaker 1: most people, I think will will adopt the hunker down

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Speaker 1: mentality and try to see what direction the markets are

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Speaker 1: going before they make any material decisions. So you're not

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Speaker 1: betting on the Saluadias or the Russians are opec to

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Speaker 1: deliver a death blow to domestic US energy any time too.

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Speaker 1: I would I would never do that for any number

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Speaker 1: of reasons, but not the least of which is I'm

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Speaker 1: just kind of basically an optimist. Of course, one of

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Speaker 1: my partners reminds me that back can I think it

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Speaker 1: was in December. I was being interviewed and I was saying, Oh,

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Speaker 1: this is not gonna be a major problem. It's gonna

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Speaker 1: blow over. This is not a thing that we should

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Speaker 1: worry about. Of Course, I could not have been more wrong.

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Speaker 1: It was a major issue that happened in and this

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Speaker 1: is another major issue, but I don't think it's the

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Speaker 1: death knell for the oil industry. You mentioned this risk

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Speaker 1: taking aspect of the oil industry, and I think that's

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Speaker 1: what a lot of people associate with it. You know,

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Speaker 1: people go out and try to find oil and some

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Speaker 1: of them strike it rich and others don't. And historically

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Speaker 1: that's been really attractive to bankers and other types of financiers.

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Speaker 1: Can you talk to us a little bit about that process,

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Speaker 1: especially in recent years. How did Wall Street and invest

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Speaker 1: jurors and big financial institutions become so entangled with US

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Speaker 1: shale well to to finance the shale revolution required a

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Speaker 1: massive amount of capital, much more than had previously been

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Speaker 1: invested in the industry back when they were drilling quote

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Speaker 1: simple vertical wells on a one off basis. This shale

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Speaker 1: revolution transformed the need for capital a hundredfold, and Wall Street,

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Speaker 1: I think didn't see a lot of other attractive opportunities.

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Speaker 1: This is coming off the financial crisis, and it was

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Speaker 1: a great place to put money to to work with

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Speaker 1: the quantitative easy A lot of money was available, it

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Speaker 1: wasn't too expensive, and if you could get some great

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Speaker 1: returns in the oil industry. Why why wouldn't you do it?

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Speaker 1: The problem is once everybody invest in a deal, as

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Speaker 1: you know, um, the return start to diminish significantly. And

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Speaker 1: that that's been the results here. Because we invested in

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Speaker 1: the US oil and gas industry. We were very successful.

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Speaker 1: We were so successful that we've kind of shot ourselves

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Speaker 1: in the foot by increasing production as much as we have,

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Speaker 1: and we the supply is going to exceed demand. That's

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Speaker 1: always gonna be a bad outcome for the supplier because

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Speaker 1: prices are going to drop down until demand picks up

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Speaker 1: or the supplies are reduced. What happened in call it

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Speaker 1: that might have been the the golden air of the

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Speaker 1: shale revolution. We were coming off that peak theory, peak

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Speaker 1: oil theory that you know, that we're running out of

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Speaker 1: oil that was being disproven. But there still was a

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Speaker 1: great demand. You know, China was actively increasing their consumption.

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Speaker 1: It really looked as if there was no end in

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Speaker 1: sight for the golden Air. In fact, you mentioned the

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Speaker 1: book that I wrote. I was writing it from through

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Speaker 1: and about September October I was about ready to, you know,

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Speaker 1: write the final chapter and say how great successful the

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Speaker 1: oil industry is and how it's learned from all of

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Speaker 1: its past mistakes and I will never make a mistake again.

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Speaker 1: And then and then, and then Thanksgiving happened, and I

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Speaker 1: had to spend another year digesting how wrong I was,

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Speaker 1: and you know, summarizing the impact that that's had on

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Speaker 1: the industry, and that I think we published the book

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Speaker 1: in and obviously a lot has changed since then. But

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Speaker 1: the main thing for oil producers, the smaller independence, is

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Speaker 1: that the access to capital is becoming severely restricted, and

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Speaker 1: that's going to really transform the industry. Is going to

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Speaker 1: make the bigger players, the majors, the internationals, much more

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Speaker 1: able to compete and get the good acreage, and the

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Speaker 1: smaller independence are just gonna struggle because they without capital,

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Speaker 1: they can't uh, they can't compete, they can't drill, they

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Speaker 1: can't acquire, and they'll just have to wait until the

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Speaker 1: markets sentiment on investing in the oil industry turns around

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Speaker 1: and then they can have access to capital again. Well,

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Speaker 1: I want to talk about that market sentiment towards oil

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Speaker 1: because it's interesting. It feels like at any given moment,

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Speaker 1: there's some overarching narrative that people will say, Okay, this

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Speaker 1: is the new normal, And you mentioned the peak oil obsession.

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Speaker 1: I remember that very well pre crisis. A lot of

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Speaker 1: people really bought into that. Recently, even before the economy

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Speaker 1: started turning down and uh the OPEC moves. There's just

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Speaker 1: been a lot of pessimism about the future of oil.

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Speaker 1: From the exact opposite point of view, people talking about

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Speaker 1: electric vehicles and some sort of permanent decline of oil demand.

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Speaker 1: That is just there's a secular shift away from oil period.

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Speaker 1: It doesn't have anything to do with the economic cycle.

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Speaker 1: Do you think that those forecasts are though that sentiment

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Speaker 1: won't end up being as wrong as the peak oil

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Speaker 1: sentiment was like in two thousand and seven two eight.

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Speaker 1: That's a tough question, to be honest with you, and

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Speaker 1: I wrestle with that a lot. I I think there

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Speaker 1: is inevitably a transition with respect to certain uses for hydrocarbons,

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Speaker 1: to renewable energy, to expand it. It can replace it

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Speaker 1: or displace it. On balance, there's always going to be

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Speaker 1: some need for hydrocarbons. The great quote by shake your

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Speaker 1: money back in early two thousand that we didn't exit

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Speaker 1: the stone age became because we ran out of stones.

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Speaker 1: You know, we're not going to exit the hydrocarbon age

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Speaker 1: because we run out of hydrocarbon. It's gonna be there's

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Speaker 1: gonna be some better invention that just replaces the utility

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Speaker 1: of of hydrocarbons. But right now there's so energy dense

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Speaker 1: and so easy to store that as a transportation fuel,

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Speaker 1: it really is unsurpassed. And obviously there's a lot of

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Speaker 1: externality costs associated with it um and I think the

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Speaker 1: industry is is addressing that. So predictions about the death

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Speaker 1: of the oil industry, or hydrocarbon industry or are probably premature.

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Speaker 1: It's a long transition period, but I think we are

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Speaker 1: in the beginning of a transition period. So on the

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Speaker 1: topic of evaluating the future price of oil, I wanted

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Speaker 1: to dig into the redetermination process a little bit more

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Speaker 1: if you could maybe walk us through how that works,

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Speaker 1: what it means for shale companies, and anecdotally, I'd be

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Speaker 1: really interested in hearing what kind of prices banks are

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Speaker 1: using for redeterminations this season. I think the last time

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Speaker 1: I spoke to you on this topic was back in

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Speaker 1: two thousand fourteen, and they were using something like fifty

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Speaker 1: dollars a barrel, and that was considered low back then.

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Speaker 1: I imagine whatever they're using now is probably going to

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Speaker 1: be even lower. Yeah, and that that's a there's a

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Speaker 1: lot in that question to unpack. But just to answer

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Speaker 1: that last question first, right now, the banks are are

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Speaker 1: resetting their price decks, which is the basis upon which

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Speaker 1: they determine how much they're willing to land against a

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Speaker 1: producers oil and gas assets. And we uh paid the

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Speaker 1: moon last fall sent out emails to about twenty five

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Speaker 1: of the energy bankers, mostly here in Houston, and that's

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Speaker 1: probably a good sampling of the universe, if not the

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Speaker 1: entirety of the universe, for what their price decks were.

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Speaker 1: We did that again two weeks ago to twenty five

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Speaker 1: banks and we've already gotten some responses before Friday of

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Speaker 1: last week, but as of the price collapse over the weekend,

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Speaker 1: we we sent out a new request to all the

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Speaker 1: same banks and saying, if you're going to redetermine your

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Speaker 1: price dex, let us know so we can include the

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Speaker 1: more current information and the initial responses we got back

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Speaker 1: from a lot of the bankers where yeah, hold off,

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Speaker 1: we're we're still looking at that, but we're gonna come

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Speaker 1: up with the new price dex. So I guess stay

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Speaker 1: tuned on what the price deck will be. But to

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Speaker 1: back up your question originally, is how is our barring

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Speaker 1: bases determined? And just on the most fundamental level, an

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Speaker 1: oil and gas producer borrowing money from a commercial bank

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Speaker 1: is UH. It's an asset based loan. But it's a

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Speaker 1: unique asset based loan because most assets are inventory, floor inventory,

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Speaker 1: or something that's out there and it doesn't disappear overnight.

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Speaker 1: It doesn't lose value necessarily UH, And so those asset

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Speaker 1: based loans are done in a different formula, but nevertheless

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Speaker 1: it's a borrowing based formula. The reason why only gas

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Speaker 1: is different is because the oil and gas is continually

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Speaker 1: being produced and depleting, and producers are drilling more wells

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Speaker 1: and replacing those reserves and so has As that cycle

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Speaker 1: goes through the company's production inventory, the banks will reevaluate

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Speaker 1: not only the total amount of recoverable reserves, but also

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Speaker 1: what value the producers expected to receive for those reserves

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Speaker 1: over the life of the loan, usually over a three

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Speaker 1: to five year period, so every six months. Because that

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Speaker 1: collateral value fluctuates, the industry has come up with a

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Speaker 1: formula that every six months banks will relook at the

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Speaker 1: producers asset base and say how much they'll be willing

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Speaker 1: to loan against it. That number historically goes up, both

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Speaker 1: because prices historically go up and producers continue to develop

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Speaker 1: and acquire and drill and increase the total number of

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Speaker 1: reserves they have. However, h what goes up can come down,

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Speaker 1: and producers are going to find that probably a lot

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Speaker 1: of the barring bases across the board at best will

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Speaker 1: be held steady, but more likely will fall down. There

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Speaker 1: their mitigants again us that a lot of producers, in

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Speaker 1: large part because the banks required have hedged their production

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Speaker 1: and so they have locked in prices on the near

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Speaker 1: term for the next twelve to thirty six months. And

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Speaker 1: if they put those hedges on in January seventh, whenever

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Speaker 1: that the Iran issue arose, they might they might have

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Speaker 1: sixty hedges on their books for the next twelve months.

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Speaker 1: Those guys are feeling pretty smart. Other people may have said,

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Speaker 1: I don't want to hedge at sixty, I want to

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Speaker 1: wait ti Ut seventy five, and those people are our

403
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Speaker 1: kicking themselves. But what the banks do not only looking

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Speaker 1: at current market prices, They're also going to look at

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Speaker 1: what hedgebook does the producer have, because that could support

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Speaker 1: a higher barring base. So not everybody's going to see

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Speaker 1: a barring based reduction, but probably on ballast they will. Right.

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Speaker 1: So this might be a stupid or naive question, but

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Speaker 1: why is there a season? Why is there a set

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Speaker 1: time when this all happens at once, as opposed to

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Speaker 1: this just being an ongoing, continuing process by the capital

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Speaker 1: markets or by the banks to always be uh in

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Speaker 1: the state of permanent uh evaluating their clients, their borrowers.

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Speaker 1: I mean, that's a that's a good question, and in fact,

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Speaker 1: banks have the opportunity as well as borrowers if they

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Speaker 1: think they're they're collateral worth of you know, twice three

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Speaker 1: times where they're getting the barring base. They have what

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Speaker 1: we call a wild card election between each six month

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Speaker 1: reree determination period to say I want you to re

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Speaker 1: evaluate my reserves. So the banks say, hey, we're going

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Speaker 1: to reevaluate your reserves, and we you know, usually aren't

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Speaker 1: gonna do that, but it's where they're going to reduce

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Speaker 1: the value. They do it every six months because it's

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Speaker 1: a process. You have to go out and engineer the wells,

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Speaker 1: update your engineering, add new wells that have been drilled, etcetera.

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Speaker 1: So it's it's not something that you kind of just

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Speaker 1: you know, check your your monitor every morning to see

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Speaker 1: what your reserve base barring base is once every year.

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Speaker 1: It's done by a third part, any resure engineering firm,

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Speaker 1: and so that's that's a cost, I don't know, fifty

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Speaker 1: hundred fifty thousand dollars. So you don't want to just

432
00:27:08,119 --> 00:27:11,200
Speaker 1: incurr that cost every day to get comfort on what

433
00:27:11,280 --> 00:27:16,399
Speaker 1: your barring bases. And from the bank's perspective, the banks

434
00:27:16,440 --> 00:27:20,040
Speaker 1: are not giving a barring base equal to exactly what

435
00:27:20,720 --> 00:27:23,920
Speaker 1: the reserves are that day. The banks are going to

436
00:27:24,160 --> 00:27:29,320
Speaker 1: discount the barring base to be st of the present

437
00:27:29,440 --> 00:27:33,480
Speaker 1: value of the future expected production from the wells over

438
00:27:33,680 --> 00:27:36,680
Speaker 1: the life of their production. So there's there's lots of

439
00:27:36,800 --> 00:27:40,560
Speaker 1: cushion in a barring base that is intended for the

440
00:27:40,600 --> 00:27:42,879
Speaker 1: banks to be protected. On the downside, because the banks,

441
00:27:43,280 --> 00:27:45,880
Speaker 1: the banks are not really getting rewarded much for making loans.

442
00:27:45,880 --> 00:27:49,520
Speaker 1: They're getting you know, base rate plus two or live

443
00:27:49,600 --> 00:27:53,440
Speaker 1: war plus one fifty, So there's no real reward for

444
00:27:53,520 --> 00:27:56,200
Speaker 1: the banks to be super risky and and therefore these

445
00:27:56,240 --> 00:28:00,280
Speaker 1: barring bases while they're set just twice a year. They're

446
00:28:00,280 --> 00:28:02,600
Speaker 1: staying with a lot of cushion, and there is this

447
00:28:02,960 --> 00:28:06,200
Speaker 1: call it wild card option for either the bank or

448
00:28:06,320 --> 00:28:09,720
Speaker 1: the bar words to trigger during a six month period

449
00:28:09,720 --> 00:28:13,280
Speaker 1: if they take the barring bases off. But I wanted

450
00:28:13,320 --> 00:28:16,560
Speaker 1: to ask you about the mix of financing for US

451
00:28:16,600 --> 00:28:19,800
Speaker 1: shale as well, because clearly we've just been talking about

452
00:28:19,920 --> 00:28:24,679
Speaker 1: the sort of reserved based bank loans UM, but shale

453
00:28:24,720 --> 00:28:28,000
Speaker 1: companies also issue bonds and they can also take out

454
00:28:28,080 --> 00:28:32,879
Speaker 1: second lean loans if they need to. How does that

455
00:28:33,760 --> 00:28:38,040
Speaker 1: dynamic or that mix of funding um end up impacting

456
00:28:38,560 --> 00:28:44,680
Speaker 1: actual appetite for shale exposure. Well, I would say the

457
00:28:44,800 --> 00:28:51,920
Speaker 1: options are dwindling for producers to access capital. The traditional

458
00:28:52,160 --> 00:28:57,560
Speaker 1: commercial bank loans are there, but bankers are not aggressively

459
00:28:57,680 --> 00:29:00,280
Speaker 1: competing against one another to increase their more or could

460
00:29:00,320 --> 00:29:04,920
Speaker 1: share in this industry, and so new new loans are

461
00:29:05,080 --> 00:29:08,680
Speaker 1: very few and far between a month. Commercial banking sides

462
00:29:09,680 --> 00:29:16,760
Speaker 1: the second clean loan market, which was very robust in

463
00:29:17,720 --> 00:29:23,360
Speaker 1: the golden air of the shell plays, there are still

464
00:29:23,480 --> 00:29:26,320
Speaker 1: some second leans, but now it's not so much because

465
00:29:26,480 --> 00:29:30,800
Speaker 1: producers are needing to grow faster. It's because producers are

466
00:29:31,040 --> 00:29:34,880
Speaker 1: needing capital to survive, and the second leane market is

467
00:29:35,320 --> 00:29:41,400
Speaker 1: significantly smaller and much more expensive. The bond market is

468
00:29:41,960 --> 00:29:46,920
Speaker 1: for all intense purposes gone, and that's a that's a

469
00:29:47,040 --> 00:29:51,600
Speaker 1: major story for producers that are facing bond maturities in

470
00:29:55,480 --> 00:29:58,480
Speaker 1: if they're unable to refinance their bonds in the next

471
00:29:58,560 --> 00:30:02,560
Speaker 1: twelve months, there really is no alternative for them but

472
00:30:02,800 --> 00:30:07,200
Speaker 1: to do either out of court or through bankruptcy exchange

473
00:30:07,280 --> 00:30:10,920
Speaker 1: of the debt for equity. And that's that's a real

474
00:30:11,000 --> 00:30:15,320
Speaker 1: problem for those producers that are publicly reporting on bond debt.

475
00:30:15,960 --> 00:30:19,960
Speaker 1: And then the fourth avenue of access for capital, traditional

476
00:30:20,040 --> 00:30:23,480
Speaker 1: capital is the stock market, and I think the stock

477
00:30:23,560 --> 00:30:27,960
Speaker 1: market spoke pretty loudly yesterday about how enthusiastically are upholding

478
00:30:28,440 --> 00:30:32,880
Speaker 1: equities and exploration and production companies. So what we're seeing

479
00:30:32,960 --> 00:30:39,120
Speaker 1: now are structured finance loans that are made with For example,

480
00:30:39,160 --> 00:30:42,440
Speaker 1: a deal we just closed last week, it has a

481
00:30:42,960 --> 00:30:47,320
Speaker 1: ten year hedge. That's pretty much unheard of because basically

482
00:30:47,400 --> 00:30:49,320
Speaker 1: there's not a lot of market ten years out. But

483
00:30:49,440 --> 00:30:53,040
Speaker 1: in order to get the capital this producer to finance

484
00:30:53,080 --> 00:30:57,480
Speaker 1: an acquisition was willing to lock in prices for ten years.

485
00:30:57,880 --> 00:31:00,200
Speaker 1: The counterparty on the hedge side was willing to do

486
00:31:00,320 --> 00:31:03,960
Speaker 1: the same thing. And that's a pretty unique structure. Question

487
00:31:04,000 --> 00:31:06,160
Speaker 1: whether or not that becomes the new the new norm.

488
00:31:06,280 --> 00:31:08,920
Speaker 1: We also saw another kind of structure which is called

489
00:31:09,080 --> 00:31:11,120
Speaker 1: a drill code, which is a I don't want to

490
00:31:11,120 --> 00:31:12,640
Speaker 1: get too deep in the weeds on that, but it's

491
00:31:12,680 --> 00:31:16,280
Speaker 1: it's basically a financial farm out that independent producers used

492
00:31:16,320 --> 00:31:18,760
Speaker 1: to use in the nineteen thirties, forties and fifties, but

493
00:31:18,840 --> 00:31:21,480
Speaker 1: now instead of a farm out from an oil company,

494
00:31:21,480 --> 00:31:25,200
Speaker 1: they're getting a farm out from private equity capital company.

495
00:31:25,840 --> 00:31:28,800
Speaker 1: You know, any time you say you can't do X,

496
00:31:29,800 --> 00:31:31,800
Speaker 1: somebody in the oil industry is going to figure out

497
00:31:31,840 --> 00:31:34,800
Speaker 1: a way to get around it. And if the markets

498
00:31:34,800 --> 00:31:37,120
Speaker 1: are telling oil companies we're not going to give you

499
00:31:37,200 --> 00:31:40,160
Speaker 1: any more money, I will guarantee the oil companies will

500
00:31:40,200 --> 00:31:42,800
Speaker 1: figure out somebody who will and it may be a

501
00:31:42,840 --> 00:31:45,120
Speaker 1: structure that may not be as attractive, but it will

502
00:31:45,160 --> 00:31:49,040
Speaker 1: be a structure that will work. And capital just has

503
00:31:49,080 --> 00:31:52,600
Speaker 1: a way of finding itself to the producers. You know,

504
00:31:52,680 --> 00:31:54,480
Speaker 1: it's not gonna be so much dumb money that you

505
00:31:54,600 --> 00:31:57,200
Speaker 1: might have seen when everybody is jumping in on the bandwagon.

506
00:31:57,680 --> 00:32:00,160
Speaker 1: It's going to be smarter money, be more expend to

507
00:32:00,360 --> 00:32:04,480
Speaker 1: be more structured. But if you have the right project,

508
00:32:04,680 --> 00:32:06,719
Speaker 1: you have the right rocks, as they say you can,

509
00:32:06,840 --> 00:32:09,080
Speaker 1: you can find the money to drill them. When you

510
00:32:09,240 --> 00:32:12,000
Speaker 1: talk about the when you talk about that ten year

511
00:32:12,160 --> 00:32:14,520
Speaker 1: hedge and you said you know there's not much market

512
00:32:14,560 --> 00:32:19,240
Speaker 1: tenures out, is that essentially the oil company agreeing to

513
00:32:19,480 --> 00:32:24,440
Speaker 1: sacrifice theoretical potential upside in the price of oil, and

514
00:32:24,520 --> 00:32:27,680
Speaker 1: then the lender capturing that upside if we get if

515
00:32:27,720 --> 00:32:31,880
Speaker 1: we were to see a major rebounding price. Yeah, although

516
00:32:31,960 --> 00:32:35,640
Speaker 1: in that's instance, the counterparty to the hedge is the

517
00:32:35,720 --> 00:32:39,600
Speaker 1: one who potentially gets the upside, and the producer is

518
00:32:39,920 --> 00:32:43,840
Speaker 1: definitely giving up upside by locking in a price today.

519
00:32:44,080 --> 00:32:49,080
Speaker 1: But if it guarantees the acquisition and the reserves are

520
00:32:49,080 --> 00:32:52,680
Speaker 1: gonna continue to produce well after the hedges roll off,

521
00:32:53,400 --> 00:32:57,400
Speaker 1: then they're probably okay with that. Plus in in in

522
00:32:57,480 --> 00:32:59,600
Speaker 1: the real world, you know, to or three years from now,

523
00:32:59,760 --> 00:33:02,240
Speaker 1: if the market turns around, they may unline that whole

524
00:33:02,280 --> 00:33:04,920
Speaker 1: transaction and put in some more conventional financing on it.

525
00:33:05,400 --> 00:33:07,560
Speaker 1: Just because you locked in a ten year deal doesn't

526
00:33:07,600 --> 00:33:10,520
Speaker 1: mean you actually wait the entire ten years and pay

527
00:33:10,600 --> 00:33:13,840
Speaker 1: it back. There's there's ways to refinance it if and

528
00:33:13,880 --> 00:33:17,240
Speaker 1: when it becomes the right decision to do or refinance

529
00:33:18,400 --> 00:33:22,880
Speaker 1: if if things get bad enough for the shale industry,

530
00:33:23,400 --> 00:33:27,040
Speaker 1: would you expect some sort of support measure from either

531
00:33:27,800 --> 00:33:31,800
Speaker 1: the local state governments or the federal government. Given that,

532
00:33:32,240 --> 00:33:34,480
Speaker 1: you know, it's now a bigger part of the U.

533
00:33:34,600 --> 00:33:37,280
Speaker 1: S economy, it's a big employer for a lot of people.

534
00:33:37,600 --> 00:33:42,120
Speaker 1: Do you think that's a possibility. Um, I really don't.

535
00:33:42,520 --> 00:33:47,600
Speaker 1: I think that the industry by and large has been

536
00:33:47,680 --> 00:33:51,520
Speaker 1: able to, you know, handle these ups and downs. Obviously

537
00:33:51,600 --> 00:33:54,640
Speaker 1: there's going to be bankruptcies, uh, and there will be,

538
00:33:55,080 --> 00:33:59,320
Speaker 1: so the ownership of these companies may change, But ultimately

539
00:33:59,400 --> 00:34:03,160
Speaker 1: the hydrocar vans will still be underground. The oil and

540
00:34:03,240 --> 00:34:05,240
Speaker 1: gas is not going anywhere. It's been there for a

541
00:34:05,320 --> 00:34:09,000
Speaker 1: million years, so it will still be accessible provided somebody

542
00:34:09,080 --> 00:34:11,680
Speaker 1: has the capital to drill and produce it. I don't

543
00:34:11,800 --> 00:34:16,800
Speaker 1: think that there would be much appetite in any sense,

544
00:34:17,360 --> 00:34:20,919
Speaker 1: except for maybe in Oklahoma and Texas congressman to even

545
00:34:21,280 --> 00:34:23,640
Speaker 1: float that idea, But but it would be shot down

546
00:34:23,719 --> 00:34:27,439
Speaker 1: by the rest of the country. So I don't think

547
00:34:28,120 --> 00:34:31,560
Speaker 1: our oil and gas producers are looking for any type

548
00:34:31,600 --> 00:34:36,960
Speaker 1: of bailout from the federal government to solve the problems. Buddy,

549
00:34:37,120 --> 00:34:38,960
Speaker 1: that was really great. Thank you so much for coming on.

550
00:34:39,400 --> 00:34:41,759
Speaker 1: That was awesome. Happy to do it, Happy to do it.

551
00:34:41,840 --> 00:34:46,400
Speaker 1: I hope, I hope my predictions about the industry surviving

552
00:34:46,480 --> 00:34:50,480
Speaker 1: are are accurate enough. And and I also hope that

553
00:34:50,600 --> 00:34:53,759
Speaker 1: this current period is the challenging period that we're faced with,

554
00:34:54,000 --> 00:34:56,520
Speaker 1: is does not last for too long and we figure

555
00:34:56,560 --> 00:34:59,960
Speaker 1: out some answers to it, because, frankly, as I think

556
00:35:00,040 --> 00:35:02,959
Speaker 1: you all know, the oil industry and what it's done

557
00:35:03,160 --> 00:35:07,520
Speaker 1: for the US economy has been phenomenal, and we don't

558
00:35:07,560 --> 00:35:09,200
Speaker 1: want to we don't want to lose the momentum that

559
00:35:09,280 --> 00:35:13,480
Speaker 1: we've built up with that, all right, thank you, buddy.

560
00:35:24,040 --> 00:35:28,040
Speaker 1: So Joe, I really love that conversation, Uh, first of all,

561
00:35:28,080 --> 00:35:31,160
Speaker 1: because it brings up a lot of memories of similar

562
00:35:31,239 --> 00:35:34,760
Speaker 1: things that we're happening in two thousand, two thousand and fifteen,

563
00:35:34,880 --> 00:35:38,920
Speaker 1: which I found really interesting then. But also this nexus

564
00:35:39,200 --> 00:35:44,800
Speaker 1: between capital being funneled by Wall Street and financial institutions

565
00:35:44,880 --> 00:35:48,000
Speaker 1: and how it sort of enters the shale industry, I've

566
00:35:48,120 --> 00:35:52,239
Speaker 1: just always found really fascinating. Yeah, you've been covering this

567
00:35:52,520 --> 00:35:54,640
Speaker 1: angle for a long time, and I did think it

568
00:35:54,760 --> 00:35:58,600
Speaker 1: was fascinating hearing him talk about, uh, you know, the

569
00:35:58,880 --> 00:36:03,480
Speaker 1: degree to which this show revolution is simultaneously a technology

570
00:36:03,600 --> 00:36:06,640
Speaker 1: story and a capital market story, and hearing them talk

571
00:36:06,719 --> 00:36:09,799
Speaker 1: and hearing you talk absolutely about the degree to which

572
00:36:10,160 --> 00:36:12,799
Speaker 1: these companies were able to innovate so fast in terms

573
00:36:12,840 --> 00:36:18,840
Speaker 1: of cutting costs after Thanksgiving. But also even with that,

574
00:36:19,560 --> 00:36:22,480
Speaker 1: you know this sort of this ten year expansion or

575
00:36:22,520 --> 00:36:25,239
Speaker 1: eleven year expansion that may be coming to an end

576
00:36:25,960 --> 00:36:31,520
Speaker 1: of risk capital. Basically that that combination really just sort

577
00:36:31,560 --> 00:36:33,879
Speaker 1: of of those two things at the same time really

578
00:36:33,960 --> 00:36:36,640
Speaker 1: just changing the entire complexion of the world or the

579
00:36:36,680 --> 00:36:40,800
Speaker 1: world's energy industry. Yeah. Absolutely, And also the market response

580
00:36:40,920 --> 00:36:43,479
Speaker 1: is just going to be fascinating to see that play out, because,

581
00:36:43,520 --> 00:36:47,600
Speaker 1: as Buddy was describing, there's such a mix of financing

582
00:36:47,719 --> 00:36:51,560
Speaker 1: options for shale companies at the moment, and each one

583
00:36:51,600 --> 00:36:54,840
Speaker 1: of those financing options impacts the other. So you know,

584
00:36:55,239 --> 00:36:57,960
Speaker 1: if you take out a second lean loan, you're probably

585
00:36:58,840 --> 00:37:02,600
Speaker 1: pushing your bond hole is further down the capital structures,

586
00:37:02,640 --> 00:37:05,360
Speaker 1: so maybe bond holders don't want to invest in you anymore.

587
00:37:06,000 --> 00:37:09,359
Speaker 1: It's it's a really interesting and complex dynamic, and when

588
00:37:09,400 --> 00:37:13,359
Speaker 1: you add a thirty price drop and Crewe to that mix,

589
00:37:13,960 --> 00:37:18,160
Speaker 1: it becomes even more interesting. Yeah. I really like hearing

590
00:37:18,239 --> 00:37:22,239
Speaker 1: them talk about the actual details of I mean the

591
00:37:22,280 --> 00:37:24,719
Speaker 1: whole reason we have the discussion because it's the time

592
00:37:24,760 --> 00:37:28,920
Speaker 1: again for banks to determine their borrowing base, but just

593
00:37:29,040 --> 00:37:31,040
Speaker 1: the discussion of how they go about that, because I

594
00:37:31,120 --> 00:37:34,279
Speaker 1: do think it's very easy to abstract away from that

595
00:37:34,440 --> 00:37:37,560
Speaker 1: and say, Okay, oil prices are down and bond yields

596
00:37:37,640 --> 00:37:40,160
Speaker 1: on junk energy debt are up, and that's bad and

597
00:37:40,280 --> 00:37:43,320
Speaker 1: so forth. But then thinking about the different ways that

598
00:37:43,440 --> 00:37:46,400
Speaker 1: still companies can hang on and survive, and you know,

599
00:37:46,560 --> 00:37:50,120
Speaker 1: I like the whole like the Texas grit of always

600
00:37:50,360 --> 00:37:54,040
Speaker 1: of finding a way either through technology or new capital structures,

601
00:37:54,760 --> 00:37:57,920
Speaker 1: even with all these body blows. Yeah, Texas grit. It's

602
00:37:57,960 --> 00:38:01,760
Speaker 1: that innovation and also the rejection in of federal support

603
00:38:02,000 --> 00:38:05,400
Speaker 1: as well. I feel comfortable saying that because my dad's

604
00:38:05,400 --> 00:38:07,799
Speaker 1: from Texas and I lived in Dallas, so I get

605
00:38:07,880 --> 00:38:11,200
Speaker 1: to say that. Um, okay, Well, this has been another

606
00:38:11,280 --> 00:38:14,920
Speaker 1: episode of the All Thoughts podcast. I'm Tracy Allaway. You

607
00:38:14,960 --> 00:38:18,120
Speaker 1: can follow me on Twitter at Tracy Alloway, and I'm Joe.

608
00:38:18,160 --> 00:38:20,879
Speaker 1: Why isn't though? You can follow me on Twitter at

609
00:38:20,920 --> 00:38:23,960
Speaker 1: the Stalwart, and you should follow our producer on Twitter,

610
00:38:24,120 --> 00:38:27,880
Speaker 1: Laura Carlson. She's at Laura M. Carlson. You should follow

611
00:38:27,920 --> 00:38:31,080
Speaker 1: the Bloomberg head of podcast on Twitter, Francesca Levi at

612
00:38:31,120 --> 00:38:34,719
Speaker 1: Francesca Today, as well as all the Bloomberg podcasts under

613
00:38:34,760 --> 00:39:00,360
Speaker 1: the handle AD Podcasts. Thanks for listening one