December 6, 2024 - On December 4th, the LSTA hosted a webinar, the Semi-Annual Oil & Gas December 2024 Update, presented by the Haynes and Boone team led by Jeff Nichols who was joined by Phil Lookadoo, Kim Mai, Laura Martone, and Roy Schwartz. After noting their two current reports which are available on their website, the Borrowing Base Redeterminations Survey(a forward-looking survey that reveals what lenders, borrowers and others in the industry expect regarding borrowing base redeterminations in the light of oil price uncertainty) and the Energy Bank Price Deck Survey(this compiles oil and gas price decks from leading energy banks and serves as an indication of price expectations used to determine producers’ borrowing bases under reserve-based loans), the team addressed asset backed securitizations (ABS) in the industry and municipal prepaid bonds.
Structured finance transactions are generally finance transactions that involve the isolation of a pool of assets (here interests in proven developed and producing wellbores) from the owner of those assets and a loan (here a note issuance) that relies on the strength of the assets rather than the creditworthiness of the owner. Thus, oil & gas ABS are debt securities collateralized by wellbore working interest in producing wells that have been transferred to an issuer owned SPV. There have been three generations of such securitizations over the past 25 years. The latest generation of securitizations evolved from the prior two generations yet include unique characteristics. Haynes and Boone was one of several instrumental players working to develop the structure in early 2019 in conversations with Fitch and other market players, including hedge providers. Over the past five years, they have been involved with about 30 oil and gas securitizations since the first one in 2019. Haynes and Boone has represented hedge providers in a broad spectrum of securitization transactions, ranging in value from smaller transactions under $100mm to more complex structures with initial issuance in excess of $700mm.
Because reserve-based loans are hard to develop and ABS is a popular alternative which is expected to do well, the general expectation is that the ABS market will grow in the coming years. Although ABS is more expensive than reserve-based lending it is significantly less expensive than high yield, and it is important to note that there is not much availability today under traditional term loans.
The team then discussed the considerations when drafting and negotiating an ABS deal, before turning to municipal prepaid bond transactions. These municipal prepaid bonds are tax exempt bonds which emerged in the 1990s. The IRS looked closely at them at that time to ensure that people were not abusing the tax laws, and in 2005 Congress passed the Energy Policy Act which provided market clarity that allowed these deals to take off.
They then summarized the key participants in these transactions, which include the municipal authority which forms a nonprofit corporation which issues the bonds and then contracts with the energy supplier and that entity receives the bond proceeds. That supplier has the obligation to deliver the energy over the life of the bond back to the issuer. On the other side of that transaction is the municipal utility which buys the gas from the bond issuer at the index price less a discount. Because the debt service of the bonds is fixed and the payment from the utility is variable, the commodity swap is key to eliminating the market price risk. Other financial Institutions will also be involved as will investors who will provide guaranteed investment contracts.
There are many benefits of these prepaid bond transactions. For the municipalities, there are cost savings and budget predictability, supply security through long-term supply contracts, and protection against price volatility in the market. For the prepayment recipient, they receive a lump sum payment with flexibility on how to spend and cheaper borrowing costs. Finally, the investors have access to tax exempt bonds backstopped by corporate credits.
Please click here for the slides and replay.
