Introduction and overview
Reserve-based lending (RBL) facilities are the main means by which small and mid-sized independent E&P companies raise debt finance to fund their upstream oil & gas operations. RBL is essentially cash flow lending where the facility is sized by reference to the then value of the borrower’s oil & gas reserves, rather than the state of its financial accounts. RBL’s flexible yet conservative nature has kept it the leading debt finance product for E&P companies all over the world for many years. The product developed independently in two separate markets, one applying in North America, in particular the US (US RBL), and the other originating in UK North Sea transactions but now applying all over the rest of the world (International RBL).
We reviewed over 30 senior International RBL facilities spread fairly evenly over the last decade, focusing on a limited number of key features. This paper summarises our conclusions which include that the International RBL debt product has been and will continue to be the dominant senior debt product in the sector, and that in at least one key feature the International RBL market may be moving close to that of US RBL.
This exercise is statistical in nature but nevertheless its results can only be made tentatively. This is because International RBL is an extremely diverse debt product. The nature and structure of the facilities vary enormously depending on many factors including:
- the credit strength of the borrower
- the location(s) of the assets
- the size of the underlying reserves
- the proportion of producing assets in the portfolio
- the oil (and/or gas) price at the time of closing and the forward curve/strip
- the risk appetite of the lenders
International RBL facilities can be seen as points on a wide spectrum. At one end they can start to resemble corporate facilities giving a lot of latitude to the borrower. At the other they can resemble project financing with strict limits on every aspect of the borrower’s business.
Despite these words of warning, in looking at each of the key features compared in our sample we can still draw broad conclusions on trends, both generally and over time. For more information on RBL facilities we recommend having recourse to a specialist text1
Size of facility
Our sample covered a wide range of facility sizes, which is reflective of the market as a whole. RBL is used by a wide range of companies from start-ups with only a handful of assets to large independents with a range of producing and development assets in different jurisdictions.
Number of lenders
Our sample group was fairly evenly distributed between bilateral facilities with one lender, a small club of 2-5 lenders, and larger clubs or syndicates of over 5 lenders. This is broadly reflective of the diverse RBL market as a whole but only reflects information available as at the signing date of the facilities – it masks deals which were originally underwritten by one or a small number of banks and subsequently syndicated to a larger group, or other secondary trading between banks. Therefore the actual number of lenders per transaction will likely be higher.
New money or refinancing
Taken at face value (primarily as to whether they were presented as amendments or an amendment and restatement of an existing facility) around two-thirds of our sample were new money facilities and one-third were refinancings. However in practice a significantly higher proportion (around two-thirds) were effectively refinancings, whether by the same or a similar club of lenders, or by a new lender group. This is not a surprise – unless a particular facility is the first debt financing for a borrower or the first after something like a transformational asset purchase for the borrower it then RBL facilities tend to be refinancings of an existing facility.
RCF or term loan
RBL facilities are typically revolving, giving the borrower flexibly to re-borrow loans which it has repaid but subject of course to the total commitments and borrowing base amount applying at the time. This is reflected by our sample in which the vast majority were revolving, but in which 5 were structured as term loans.
The tenor of International RBL facilities is typically 5-7 years and this is reflected in the survey. This is always subject to a reserve tail date limitation whereby the facility life is cut short if less than 25% of the reserves subsisting at the signing date remain to be produced. Associated debt products, in particular junior or mezzanine debt, tend to have shorter tenors of up to 3 years. If anything the recent trend is away from 7 years towards slightly shorter maturities. In practice RBL facilities are usually refinanced far in advance of their stated maturity.
Location of borrowing base assets
Around half the facilities in our sample were expressly made against assets in more than one jurisdiction, reflecting the international nature of the product.
The chart above again illustrates the geographically diverse nature of International RBL. Our survey covers most but by no means all of the major asset basins in which RBL been applied.
Asset level security
The security package in RBL transactions will normally include at least share security over the borrower and other key guarantor and/or asset owning entities in the borrower group, and security over bank accounts. English, Scottish and other relevant group companies incorporated in common law jurisdictions will also often grant at least a floating charge over their assets. However taking (and indeed enforcing) asset level security over petroleum licences, concessions and the like is extremely difficult in many jurisdictions and a cost benefit analysis may be required. The security position cannot be easily summarised for many facilities in our sample and so the pie chart only covers around two-thirds of the facilities reviewed. For these purposes we ignored security taken over insurances or hedging, which is fairly standard.
There are always one or more technical banks in an RBL facility, typically those with in-house petroleum engineers who can effectively lead the lenders’ view as to the status and debt capacity of the assets underpinning the facility. Historically we have seen the role being dominated by a group of around 5 banks, however in the last few years we are seeing more banks undertaking the role, albeit often in a joint capacity.
The facility agent on RBL deals is almost always a bank which is or can act as technical bank. On deals which are not bilateral (with only one lender) we again tend to see a small number of banks dominating the role.
Letters of credit
International RBL facilities often include a letter of credit facility and this is reflected in our survey. They allow borrowers to post security under field development contracts or to fulfil decommissioning security obligations. The latter has been a very significant issue in many North Sea deals in recent years and some RBL facilities come to look like glorified decommissioning letters of credit. Since the global financial crises far more attention has been paid to whether there is an issuing bank which issues the letters of credit on behalf of the lender group. At times very few banks have had a sufficient credit rating to meet the demands of the underlying letter of credit beneficiary, and issuing banks are increasingly nervous about the credit picture for other lenders in the consortium. On occasion each lender issues its own letter of credit pro rata to its commitments under the facility and there is no issuing bank.
RBL facilities are used by companies based all over the world and to finance assets all over the world. It is then perhaps a little surprising that only around half of our sample were multi-currency, with a small number of these available in more than 2 currencies. On the other hand revenues for E&P companies usually comes in US dollars, particularly for oil sales, and local currency costs are often carefully structured around using different means - even if the facility cannot be drawn in local currency there is often some associated debt than can be or the borrower group is permitted to retain some cash in local currency outside of the secured accounts.
Margins are of course commercially sensitive and so we only comment that RBL facilities are effectively senior debt, with relatively low margins, and that ratchet or similar mechanisms are often included so that the margin will change over the life of the loan. This may be automatic depending on the used tenor of the facility or depend on, for example, performance under financial ratio testing, the amount of the facility drawn, the currency under which the facility is drawn, and whether key development assets reach project completion as defined in documentation (effectively de-risking the facility).
PLCR, LLCR and other financial ratios
RBL debt sizing is typically done by reference to the lower of the net present value of the relevant assets during their field life (PLCR) or during the tenor of the facility (LLCR). As a rule of thumb the PLCR for senior debt tends to be 1.5 and the LLCR 1.3. Over half of our sample followed this rule of thumb for the PLCR. A lower number, around a third, did this for the LLCR, both because a wider range of figures is used for the LLCR and because an LLCR is not always used as a debt sizing tool.
Many RBLs contain other financial covenants (including a debt service cover ratio (DSCR)) and this is also reflected by our sample. These differ significantly from deal to deal. For the larger RBL facilities which tend to resemble corporate facilities, the financial ratios tend to resemble those found in normal corporate facilities.
All these ratios and covenants can be used for many purposes in addition to debt sizing and events of default, for example margin ratchets, drawstops and dividend blocks.
Capex add back
RBL facilities often incorporate a concept of capex add back into the debt sizing provisions, which usually give the borrower a credit for monies it is projected to spend developing the borrowing base assets over the coming 12 months. The fine details are always individually negotiated. A large majority of our sample included such a mechanism.
Resolution of disputes on model assumptions
US RBL facilities often give banks wide discretion on an individual basis as to how they each want to resize the facility each redetermination. International RBL facilities tend to set out in detail how the redetermination process works, including how technical and economic assumptions are updated. Our sample shows there has been a significant change here since 2008 in that disputes over assumptions are now ultimately solved by the banks (either the technical bank(s) or the majority lenders) rather than by an independent expert. This appears to move the International RBL model closer to US RBL. However in practice the difference may be slight as examples of disputes going to an expert are rare, with the modelling and redetermination process really being a relationship exercise between the borrower and the banking group. In happier times if there were a breakdown in this relationship the borrower could refinance with different banks.
Group wide liquidity testing
Historically RBL facilities tended to focus only on the borrower group’s producing and late stage development assets. The approach on this shifted when a number of facilities became stressed after the global financial crises and the oil price down turn around 2008. One notable borrower, Oilexco, became insolvent in part because of significant unfunded exploration, appraisal and early stage development spending commitments. This all led to group wide liquidity testing covenants, over and above the running of the normal model, being added to RBL documentation.
So although in our sample around half the facilities included such liquidity testing, this was extremely rare prior to 2009 and generally ubiquitous thereafter.
Drawing together some of the tentative points throughout the analysis section above, we believe the findings or our survey have illustrated the diverse and international nature of International RBL and uncovered some trends of interest to both lenders and E&P companies. We conclude that the International RBL debt product has been and will continue to be the dominant senior debt product in the sector, albeit in the future used increasingly alongside a more and more complex array of tools in an E&P company’s capital structure. Notwithstanding the relatively large number of RBL facilities in distress at the time of writing, particularly in the US, the product as a whole has a low history of default rates and an even lower rate of losses for senior lenders – an indication that deals are generally conservatively and well structured.
1 For example, Ross-McCall and Thomas, reserve-based lending in “Energy and Resources Financing” (1st edition) published by Globe Law and Business in 2015.