A crucial time awaits US independent producers, as many companies will have their ‘borrowing bases’ re-determined by banks on 1 October. SEC guidelines would require companies to recalculate the size of their reserves using around $50 per barrel for oil and $2.7 per mcf for gas. We think a 30% write-down in reserves is not unreasonable, based on the lower oil price.
Our base case assumes lenders will not turn off access to capital overnight as ultimately banks could face some significant write-downs if many US producers (their clients) are allowed to go bankrupt. So, conditions are likely to be relaxed and will impact only those with very high debt burdens. But, should the reserve revisions be large, a material amount of output will be at risk.
Not surprisingly, there has been a shift in mindset, with producers starting to focus on ‘spending within cashflow’. Even those with weaker financials are delaying well completions, aiming to preserve cash to reassure banks they can keep afloat. Companies not compliant with credit agreements will need to force through sales or refinancing to make up for lost credit.
But given steep decline rates, cutting Capex to reduce costs will eventually erode production growth. Moreover, the only way some are managing to renew their borrowing bases is through forced hedging at current prices, which will create negative mark-to-market losses later.
So while production will rebound once prices recover, the pace of growth will be slower and more sustainable going forward, especially if oil majors get involved. For now, declines are stepping up and we have revised our 2016 US production growth forecast to flat y/y next year, with rising GoM output offsetting falling tight oil production, which will provide a floor for prices.