March 2019
By Vikram Nath, Director – Head of Asset Management & Portfolio, Oil and Gas, Natixis

While the Reserve Base Lending (“RBL”) has been the staple form of financing for any sizable sub-investment grade Exploration & Production (“E&P”) Company in the United States, the scope of such RBL financing has always been limited to the Borrowing Base primarily established by Proved Developed Producing (“PDP”) reserves. Most of the banks (American or International) operating in the upstream energy sector in the United States have a portfolio of RBL borrowers and are generally comfortable financing within the confines of a typical RBL structure. However, a typical RBL financing in the US cannot be instated unless a company is already producing. Pre-production financing needs are generally met by non-bank investors which can invest through 2^nd Lien Term Loans, quasi-equity financing or equity financing. The cost of capital for these types of financing could easily range from low-to-high teens, or even higher in case of equity financing. As such, the common capital providers for such early-stage companies are Private Equity players (and some are focused solely on energy financing while other top Private Equity players in the US have a robust energy group), Credit Funds, Hedge Funds and last but not the least – Family Office investments.

This is in sharp contrast with financing options that are available to early-stage E&P companies outside the US. Companies operating in Europe, Africa, Asia and even Latin America have access to a cheaper form of bank financing albeit with tighter structures than a typical US RBL. Let’s call this financing product as “International RBL” for the lack of a standard term for this financing to distinguish it from US RBLs.

An obvious question then is why would the banks active in the US upstream energy space not provide the International RBL type credit facilities in the US. While there is no straightforward answer to this question, it is the author’s belief that such banks have not felt a need to provide such financing to augment their businesses. There are around 500 upstream companies in the US that have a likely need for a US RBL. This provides plenty of business to the banks in this sector and the top banks operating in this space would have over 150 customers each for US RBLs. In contrast, the International RBL is a specialized form of financing that needs dedicated teams with skill sets that may have limited overlap with the skillset required for US RBL. Secondly, although there is nothing that restricts an International RBL to be set-up for onshore E&P companies, as we will discuss later, the structure is predisposed to suit offshore financing needs. Given that there are only a handful of offshore independent E&P companies in the US, compared to elsewhere in the world, US energy banks have little motivation to have this product in their suite of offerings.

Division of Tasks in setting-up an International RBL Credit Facility

Unlike a US RBL, where the admin agent performs virtually all the tasks (structuring, financial modeling, engineering analysis and Borrowing Base recommendations) independently, the responsibilities in an International RBL are shared amongst a subset of lending banks. Given below is a break-down of responsibilities of each of these banks:

International RBL Inception Steps

The process of the establishment of an International RBL credit facility is elaborate as the credit facility is highly customized to the needs of the individual customers. The illustration below depicts a high-level summary of the steps involved in setting up an International RBL credit facility.

Key Terms and Concepts in Structuring an International RBL

First things first – an International RBL is structured more like a project finance transaction with considerable restrictions on the use of proceeds, drawdown schedule and a number of milestone tests that need to be completed throughout the life of the credit facility. Given below is a high-level overview of the key concepts and definitions that one may come across while setting-up an International RBL.

1. Facility Type: An International RBL could either be set-up as a ‘Revolving Credit Facility “RCF” or a ‘Term Loan Credit Facility’. An RCF provides more flexibility to the Borrower as they can borrow or repay at their discretion while a Term Loan is generally preferred by banks as they provide a consistently funded source of interest income. Additionally, if there are any potential non-bank participants in the credit facility, then managing an RCF would be very difficult as the potential non-bank participants may not have the necessary support and infrastructure to manage day-to-day cash borrowing/repayments emanating from the RCF.
2. Facility Amount: This is the maximum amount that could be borrowed under the credit facility. The availability of funds depends upon the lower of the Facility Amount and the Borrowing Base (see below). Generally the Facility Amount would start to amortize after 18 months to 2 years of the close of the credit facility and would become zero at the maturity date of the credit facility. Unlike a US RBL where the credit facility is expected to be refinanced perpetually, the International RBL is designed to be repaid completely with the cash flows from the underlying assets.
3.  Borrowing Base: This is the maximum credit amount that could be supported by the future cash flows generated by the identified ‘Borrowing Base Assets’ of the Borrower. The determination of the Borrowing Base is a highly specialized task and the banks offering International RBL employ in-house Petroleum Engineers who lead the technical due diligence for establishing the Borrowing Base.
4.  Loan Life Cover Ratio (or LLCR): A negotiated collateral coverage ratio between the borrower and the lead banks which is critical to establishing the Borrowing Base
5. Field Life Cover Ratio (or FLCR): A negotiated collateral coverage ratio between the borrower and the lead banks which is critical to establishing the Borrowing Base.Note: (i) If both LLCR and FLCR are present, the Borrowing Base calculated by the lower of the either ratios is the established Borrowing Base.(ii) CAPEX Addback adjustments are provided to give credit to the portion of the CAPEX that will be met by funding sources other than the credit facility in question.
   
   
   
6. Equity Support Guarantee: As an International RBL is put in place during the development phase of a field, there is always an inherent completion risk associated with the project. Equity Support Guarantee provides additional comfort to lenders in case of any cost overruns during the development phase. As a result, as the project moves closer to completion, the guarantee amount is reduced accordingly.
7. Debt Service Reserve Account (DRSA): This is a ‘Reserve’ account that is established to service debt obligations for several months (which is again negotiated) on a rolling forward basis.
8. Milestone Tests: As an International RBL is structured more like a project finance transaction there are several milestone tests which a Borrower may need to complete in order to maintain access to the credit facility. Examples of these milestone tests could be:

Cost to Completion Test (until Completion): To test that there is sufficient liquidity to complete the development and reach technical Completion (also a defined term in the credit agreement).

Completion Test: Tests that need to be conducted at the end of drilling and development of the project.

Distribution Test: Test that need to be conducted prior to any cash distribution to the equity holders of the project.

International RBL and Onshore Unconventional Companies

The International RBL structure may not be suitable to onshore unconventional (read shale) as these companies do not commit CAPEX on a long-term basis in order to remain agile. Consequently, these companies have the ability to adjust CAPEX according to the short-term commodity price environment.  In contrast, the tenets of an International RBL is based on a long-term commitment from the project sponsors with pre-determined CAPEX plan. Additionally, the presence of a large number of wells makes the asset level tracking difficult. On the other hand, there are much smaller number of wells in case of an offshore development project, resulting in tracking of drilling/development of an offshore well more akin to the tracking of a project and hence making the financing option suitable for a project finance style financing.

Conclusion

The International RBL financing structure is a viable option for pre-production stage companies looking for a cheaper source of financing than quasi-equity structures. Although the structure is more restrictive than a general corporate financing, the capital costs thus saved (compared to quasi-equity or debt financings from credit/hedge-funds) compensates for the tightness in the structure. This financing structure is hugely popular in other parts of the world and there is no reason why this should not be available to companies operating in the US.