The oil patch may have dodged a financial bullet.
When Canada’s top court ruled early this year that environmental cleanup trumps the interests of secured creditors in bankruptcies, some energy executives worried their credit lines would get slashed. So far, the banks have shown restraint.
Small and midsize producers are undergoing their first reviews of bank credit facilities after what is known as the Redwater decision, and analysts, executives and industry insiders say lenders are more cautious, but few producers have been hit with wholesale reductions.
“Over the last couple of years, this issue has become a lot more topical and I think the banks have likely made those adjustments [to debt calculations] beforehand," said Jeremy McCrea, analyst at Raymond James Ltd. “From an equity standpoint, it is a sign of relief.”
After four years of downturn in Canadian oil and gas, the remaining producers have largely improved their financial health by selling assets and paying down debt, which has helped their case with the banks, he said.
In January, the Supreme Court of Canada ruled that the “polluter pays” principle takes precedent even when companies go bust, meaning that any money left in a bankruptcy must go first to cleaning up and reclaiming spent and non-commercial wells. The 5-2 decision overturned lower-court rulings that effectively allowed insolvent Redwater Energy Corp. to sell its most profitable wells and transfer the rest into an industry-funded – and overburdened – orphan-well cleanup program.
Environmental advocates, who have sounded the alarm over a surging number of wells requiring cleanup and reclamation, praised the decision. But some industry officials and analysts had warned it could create a new financial squeeze on producers when new capital has been elusive.
Oil-patch lenders contacted by The Globe and Mail, such as ATB Financial, Canadian Western Bank and National Bank of Canada, declined to comment on the impact of the court decision. Credit facilities, reviewed twice a year, are based on such factors as reserves, existing debt, commodity prices and cash flow forecasts. Environmental obligations tied to abandoning and reclaiming old wells now carry more weight.
The oil-industry cleanup problem looks to be worsening. At the end of April, Trident Exploration Corp. shut down operations, leaving behind a $329-million bill to clean up 4,700 wells. Its executives cited the Redwater ruling for their decision to walk away and leave the assets in the hands of the regulator.
Industry sources say the impact on bank-line amounts has not been as dire as many feared. However, some lending syndicates have included new covenants, such as requirements that companies remain above the Alberta Energy Regulator’s (AER) minimum assets-to-liability ratio standard for environmental cleanup capacity, known as the liability management rating, or be deemed in default.
Previous pull-backs by the banks have hit the industry hard. In 2015 and 2016, lenders cut their exposure as the collapse in crude prices squelched cash flows and pushed debt ratios well beyond comfort levels. Many junior and midsize players were hit with sharp reductions in their lines of credit, and some were pushed into bankruptcy.
A positive factor stemming from the Redwater decision is more clarity for the industry and investors on a large problem, said Stacey McDonald, a corporate director and former energy analyst.
“I think it helps to have everyone know where they stand. It sounds like there are still some companies that are in trouble. For some of the gas companies, this could hypothetically push them over the edge sooner. It just makes the banks move a little bit faster," Ms. McDonald said. “But I don’t get the sense that’s imminent. My feeling would be that’s probably more in the fall.”
Pine Cliff Energy Ltd., a gas producer with nearly $200-million in cleanup liability on an undiscounted basis, put itself on a debt diet rather than deal with reductions imposed by lenders. Phil Hodge, Pine Cliff’s chief executive, said have company’s wells have unusually long production lives, which are not reflected in the abandonment obligation calculation. The company has reduced its bank facility to $5-million from $170-million in 2015, and plans to eliminate it completely.
With reporting from James Bradshaw