Specific Financing Alternatives For The Independent Operating Company
Authors: Mintz Forest 
Published: December 2007

The independent oil and gas producer frequently finds it advantageous to borrow against the value of his hydrocarbon reserves. This paper considers the requirements for a production based loan and the calculations that a bank would perform to arrive at a revolving credit/term loan will be discussed. A typical outline for each type of loan is presented. Finally, a comparison of major considerations in the three financing techniques is shown.

Introduction

The need for additional capital for drilling, acquisition, refinancing of existing debt, or general corporate purposes is an ongoing activity for most oil and gas companies, particularly the smaller independent producers. Traditionally, funds can be raised as producers. Traditionally, funds can be raised as debt based on the strength of the company's balance sheet. However, the largest asset of a producing company, its reserves, does not appear on the balance sheet at a realistic value because of traditional cost based accounting practices. The Reserve Recognition Accounting system proposed by the Securities and Exchange Commission is meant to rectify this situation. In the meantime, many energy orientated banks are fully aware of the value of reserves, and are able to structure loans to fit the needs of a producing company with repayment to be derived from the proceeds of the sale of future production. All of these loans are based on an production. All of these loans are based on an engineering appraisal of the reserves, the cash flow available for debt service, and the particular circumstances of the borrower. This paper discusses the engineering and financial appraisal, three of the basic types of production based loans, and typical covenants and conditions that are required for production loans.

ENGINEERING AND FINANCIAL APPRAISAL

An evaluation of the reserves backing a production loan is of utmost importance to a bank. In virtually all cases a bank will require an appraisal report by a well recognized independent engineering consulting firm. This report will be reviewed by the technical staff of the bank at which time any necessary adjustments will be made to comply with bank practices, and a loan value will be calculated. The most important considerations reviewed by the bank are:EngineeringBasis of reserve estimates - a judgment will be made on the probable accuracy of the reserve figures. Estimates based on well established production performance will be given the most credibility with estimates derived from volumetrics, analogy with similar reservoirs, or a computer simulation of new producing zones given lesser weight.Classification of reserves - Generally, only proved producing reserves are acceptable collateral for a bank. This is basically because only producing reserves provide cashflow for debt service, and only the provedcategory are certain enough in magnitude. In particular instances, proved non-producing or proved undeveloped reserves are includedif wells are simply awaiting a sales outlet, or there is a firm development commitment from the borrower.Geologic considerations - The bank engineer will evaluate such geologic condition as sand continuity, faulting, reservoir energy, spacing, well productivity, and history of the formation to arrive at a judgment on the quality of the reserve figures.