Last week, amid a renewed bout of crude carnage, Morgan Stanley made a rather disconcerting call [7] on oil.
"On current trajectory, this downturn could become worse than 1986: An additional +1.5 mb/d [of OPEC supply] is roughly one year of oil demand growth. If sustained, this could delay the rebalancing of oil markets by a year as well. The forward curve has started to price this in: as the chart shows, the forward curve currently points towards a recovery in prices that is far worse than in 1986. This means the industrial downturn could also be worse. In that case, there would be little in analysable history that could be a guide to this cycle," the bank wrote, presaging even tougher times ahead for the O&G space.
If Morgan Stanley is correct, we’re likely to see tremendous pressure on the sector’s highly indebted names, many of whom have been kept afloat thus far by easy access to capital markets courtesy of ZIRP.
With a rate hike cycle on the horizon, with hedges set to roll off [8], and with investors less willing to throw good money after bad on secondaries and new HY issuance, banks are likely to rein in credit lines in October when the next assessment [9] is due. At that point, it will be game over in the absence of a sharp recovery in crude prices.
Against this challenging backdrop, we bring you the following commentary from Emanuel Grillo, partner at Baker Botts's bankruptcy and restructuring practice who spoke to Bloomberg Brief last week.
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Via Bloomberg Brief [10]
How does the second half of this year look when it comes to energy bankruptcies?
A: People are coming to realize that the market is not likely to improve. At the end of September, companies will know about their bank loan redeterminations and you’ll see a bunch of restructurings. And, as the last of the hedges start to burn off and you can’t buy them for $80 a barrel any longer, then you’re in a tough place.
The bottom line is that if oil prices don’t increase, it could very well be that the next six months to nine months will be worse than the last six months. Some had an ability to borrow, and you saw other people go out and restructure. But the options are going to become fewer and smaller the longer you wait.
Are there good deals on the horizon for distressed investors?
A: The markets are awash in capital, but you still have a disconnect between buyers and sellers. Sellers, the guys who operate these companies, are hoping they can hang on. Buyers want to pay bargain-basement prices. There’s not enough pressure on the sellers yet. But I think that’s coming.
Banks will be redetermining their borrowing bases again in October. Will they be as lenient this time around as they were in April?
A: I don’t know if you’ll get the same slack in October as in April, absent a turnaround in the market price for oil. It’s going to be that ‘come-to-Jesus’ point in time where it’s about how much longer can they let it play. If the banks get too aggressive, they’re going to hurt the value for themselves and their ability to exit. So they’re playing a balancing act.
They know what pressure they’re facing from a regulatory perspective. At the same time, if they push too far in that direction, toward complying with the regulatory side and getting out, then they’re going to hurt themselves in terms of what their own recovery is going to be. All of the banks have these loans under very close scrutiny right now. They’d all get out tomorrow if they could. That’s the sense they’re giving off to the marketplace, because the numbers are just not supporting what they need to have from a regulatory perspective.
