Since their introduction, asset backed securitizations (ABS) have caused some head scratching among E&P companies. At first, the big question was “What are they?” But as the breadth and diversity of ABS transactions has grown, upstream companies are now beginning to ask, “What can they do for me?”
The answer, as it turns out, is quite a lot.
Getting off the ground
The first upstream oil and gas ABS took place in 2019 when EnCap Investments-backed Raisa Energy, an owner of non-op assets, closed the industry’s first rated securitization of oil and gas wells.
There was skepticism whether securitization could even work in oil and gas because similar structured financings had been tried with volumetric production payments, but it was difficult to get those rated by rating agencies, said Daniel Allison, partner with Sidley Austin.
The initial Raisa deal was followed by three more that ultimately resulted in Raisa raising $1 billion in gross proceeds through securitization of almost 13,000 wells in 60 counties across 10 states, according to company materials.
With ABS deals, producing assets are dropped down into a special purpose vehicle and production is protected with aggressive hedging—up to 90%—out five years to seven years. That hedging enables ABS deals to secure a better rating from the ratings agencies, BBB or better, resulting in a lower interest rate.
Since 2019, dozens of ABS deals have been completed in the upstream space. While eye-catching, these deals have colored the general perception of what can and can’t be done with ABS.
“If you take it back to the initial deals, the first few were conventional gas assets,” said Victor Mendoza, managing director and head of oil and gas securitizations at Donovan Ventures. Although there is a small portion of investors who will strictly invest in gas, most are agnostic, Mendoza said.
Rather, a primary driver for those early deals came down to deal flow, Mendoza said. Natural gas producers, particularly those with conventional wells, needed to monetize, yet M&A or A&D were not open to them, he said. So, they turned to an ABS. “It’s a financing tool that can be used as a monetization tool,” Mendoza said.
The futures curve also plays a significant part, said Anuj Bhartiya, senior managing director of Guggenheim Securities. Natural gas’ future curve makes issuers more willing to lock in prices than they would with oil producers, he said.
While returning capital to investors is one of several uses of ABS proceeds, issuers have used proceeds to refinance RBL debt, cover capex or corporate development costs or, more recently, acquisition financing.
Maturing market
As the number of ABS deals has grown, so has investors’ confidence with the asset and the types of deals they are willing to underwrite.
“The trend has absolutely changed to allow both unconventional and oilier deals,” Mendoza said. “Investors have definitely shifted focus and the pipeline of transactions that are getting closer to market are more liquids heavy,” he said, noting he is currently working on a 100% liquids deal.
Mendoza said he’s aware of deals that have been done involving unconventional wells in the Permian Basin, Eagle Ford and Barnett shales. California, with its significant conventional production, might also see an ABS, he noted.
Some of the first wells Raisa Energy securitized were oil heavy, Bhartiya said, so oil has been a part of the ABS story from the beginning. Another example is Midcontinent-focused Presidio Petroleum, which completed a securitization on wells that were more than 50% oil, he said.
Although commodity, well type or geography are not constraints, one area that does concern investors is well diversification.
In earlier deals, there was the notion that thousands of wells were necessary to allay investor concerns, “but that is definitely not a must-have in deals anymore,” Mendoza said. Mendoza has seen an issuer with fewer than 200 oil producing wells secure an investment-grade rating from a rating agency.
The main issue is how much PV-10 value is concentrated in any single well, he said. If a single well represents one-quarter of the total value, it doesn’t mean a deal can’t get done, but it does mean the ABS will need to be priced for the greater risk, which means a lower advance rate. Excellent well diversification will result in higher advance rates of up to 65%, and in some situations even higher, but greater well risk will reduce that rate.
The wells also need to have been drilled and producing to show their stability, said Bhartiya. “The wells need some seasoning on them,” he noted. But issuers need not be active producers. Bhartiya noted that Raisa was a non-op owner, and that he has also seen minerals owners that have used ABSs to monetize some of their holdings.
What’s next?
Early ABS deals were notable for the length of time, 12 months or more in some cases, needed to complete and higher legal costs, said Sidley’s Allison. But the duration and costs have come down dramatically.
ABSs have been completed in a little as six weeks, making them competitive with more traditional senior secured loans or high yield offerings, he said. That opens up the ABSs to a wide range of potential issuers.
Because ABSs have been used in other industries, innovations from those other sectors are being introduced for oil and gas issuers. One emerging trend is the master trust, which enables serial issuance of securitizations as new assets get dropped into an existing structure, Allison explained, further lowering costs and transaction times.
Donovan Ventures’ Mendoza envisions improvement in terms for E&P companies, such as an easing of the stringent hedging requirements.
Guggenheim’s Bhartiya noted that more flexible hedging arrangements can be put in place so that producers can retain optionality with regards to changing commodity prices. Such flexibility will likely impact other parts of the structure, and could result in lower advance rates, he noted.
One area Bhartiya sees as promising is the use of ABSs for acquisition finance. Guggenheim helped put together an ABS to enable PureWest Energy to sell assets to a family office.
“I don’t think it would necessarily be something that could be applied in all acquisitions. But where you have a willing buyer, a willing seller, and the timeline matches, it’s definitely something we expect to see being used in future acquisitions in the right scenario.”
ABS deals
Although dozens of ABS deals have been done, most are private. Below is a list of companies that have done publicly disclosed deals.
