Current Developments in Petroleum Financing
Authors: Stevens T.G. 
Published: December 2007

The event that has caused the greatest recent change in petroleum financing is the Tax Reform Act of 1969. Principally, the major losses to the petroleum industry because of this new law are the discontinuance of production payment financing and the reduction in percentage depletion. A major portion of the business done by the large oil banks a few years ago, especially during the late 50's and early 60's, was in production payment financing. The retained production payment, or ABC method, was used extensively production payment, or ABC method, was used extensively and accounted for the acquisition of nearly all the properties purchased during this period. Besides properties purchased during this period. Besides innumerable small transactions, some of the larger acquisitions made with this type of financing were the purchase of Monterey Oil by Humble; Honolulu by Pan American and Getty; Plymouth by Marathon; and Delhi-Taylor by Conoco and Tenneco. Loss of the retained production payment financing method, coupled with the reduction in percentage depletion, should cause a significant reduction in the value of oil properties, assuming all other factors involved in the transaction remain the same. Actually, it is too early to tell whether or not this reduction in market value will really take place, because since the changes went into effect there have not been enough sales of properties in the fields that had an established market value to make a valid comparison. The carved-out production payment was a financing transaction used nearly always at year end to obtain current income so as to maximize depletion. Essentially, the new tax law treats the ABC and carved-out production payments as loans. Therefore, income which formerly would have been applied tax free to the retirement of a production payment is now treated as income subject to depletion. Another major change that has occurred in oil financing during the past few years is the virtual cessation of development financing. This type of lending is what really got oil banking off to a running start during the 30's and 40's and was done extensively until only a few years ago. Development financing basically involved advancing money to an operator to pay development costs as new wells were successfully completed on the collateral property. Although some of this type of lending is still done, the volume is far less than it once was. The principal reasons for the decline in this type of lending are the demise of the independent operator, who was the principal customer for this type of credit, and the lack of success in finding new oil and gas fields of the magnitude that would require development financing. Yet another major change is in the increasing complexity of oil-related financing. A few years ago most of the petroleum loans were secured by oil in the ground. Typically, these loans may have involved acquisitions, funds for building a gasoline plant or constructing a gathering system, or for financing purchase of compression equipment. But essentially they purchase of compression equipment. But essentially they all involved an appraisal of oil or gas reserves that, when produced, generated (either directly or indirectly) revenues necessary for the retirement of the loans.

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