March of the Administrators and gradually emerging from the hedge!

Having been in the industry for over 30 years I thought I had seen most things. One thing that has surfaced in abundance in late 2015 and early 2016 is the failure to pay, and the issuing of default notices to oil and gas companies in joint ventures. This was a fairly rare occurrence previously, and restricted to discrete companies that had somehow managed to get themselves into a particularly difficult financial situation. Over the last year this issue has become widespread, with companies that would normally be considered well-managed, getting into difficulty due to the dramatic oil price drop savaging their income and rendering them unable to cover their debt repayments or fund their ongoing spend. Unless the default is remedied, the licence interest is typically forfeited with the other joint venture participants taking their pro-rata share. This is fine in a world where the licence interest has some value, but not when it has negative value and ongoing liabilities that require funding. Suddenly failure to pay can spread, as companies fail and others in the joint venture are required to pick up a larger share of something that has negative value and ongoing liabilities. This is the strange world that the North Sea (and other areas) finds itself in at the present time. Normally in a low oil price world, one would expect companies that are in distress to be picked up cheaply. In the North Sea this is not happening in most cases as many distressed companies currently have negative cash flow or negative value or both. Consequently there are a whole raft of companies that are up for sale by banks or administrators that can find no buyers. How this will eventually unwind is any body’s guess. It does demonstrate the vast amount of cash and value that has been sucked out of the oil and gas producers and handed to consumers in what is in effect a subsidy. This situation cannot continue for much longer and must rebalance at some point.
In this world, there is plenty of committed activity that is currently not 100% funded as some of the companies that originally made the commitments no longer have sufficient funds to honour them. No doubt the lawyers will find plenty of work while this world unwinds. The knock on effect can be that suppliers want the money up front before they will enter into a contract. In a world where there is very little money to go round, parking cash up front in an escrow account will only assist in stopping or stalling any new activity. OPEC has applied the brakes very hard, indeed so hard that they may well have seized in some places! It may take some time before forward momentum can be re-established, and when it does, it will likely be done with considerable caution and at no great pace. This will of course only amplify the next cycle in this industry.
Some companies, notably onshore USA, have protected themselves to a reasonable degree in the immediate term by having oil and gas price hedges in place, significantly above current prices, that have helped maintain cash flow and activity levels. These of course will eventually unwind, increasing their exposure to current prices. This has been a significant factor in production of light tight oil in the USA decreasing much more slowly than many anticipated. The opposite will of course be true during any upturn, restricting cashflow and activity levels for those companies that have been required to hedge near the bottom of the market.
North Sea E&A activity has as predicted been extremely quiet over the last few months. By the end of January active E&A wells had fallen to zero, which is the first time I can ever remember this happening. Indeed as I write there has not been a single E&A well spudded this year on the UKCS. The prediction is that only around 16 E&A wells will be drilled in the North Sea in 2016, significantly below the level required of around 50-60 wells per year to access the remaining yet-to-find of around 9 billion boe within a reasonable time frame.
Next month sees the DEVEX Conference being held at the AECC in Aberdeen on the 18th & 19th May. Places are for the first time free, but numbers are currently limited to 300 so please make sure you utilise your place if you are fortunate enough to be allocated one.