Oil Price Increase Will Not Come Fast Enough To Save Alberta
“There’s just no cash.” That’s the Coles Notes from a senior banker describing the book of oil service loans he manages for one of Alberta’s leading lenders. There’s simply not enough cash flow to support current levels of debt.
Bankers and borrowers have kicked the can down the road about as far as they can as more oilfield service (OFS) and exploration and production (E&P) companies default on their loans and seek more relief on lending covenants. While a significant oil price increase to lift all the sinking boats will surely come, it won’t happen soon enough. More of the same won’t work.
Oil industry debt is everyday news. But the discussion is about the symptoms, not the ailment.
Companies cannot borrow their way out of debt. Equity capital is only available at distressed valuations. Specialized OFS assets will fetch only a fraction of replacement cost—if somebody actually wants them. Although oil and gas reserve valuations are down by half, borrowers are being forced to sell them anyway to repair balance sheets. The last four months of 2015 will be very difficult for any company with meaningful amounts of debt. Same for their lenders, the other signatories to the loan agreement.
As the banker said, “There’s just no cash.” Here’s what it means.
The foundation of global credit markets is based upon the borrower’s capability, obligation and commitment to pay the money back. The amount of money anybody can or should borrow is dependent upon free cash. Not forecast cash flow, not earnings before interest, taxes, depreciation, and amortization (EBITDA), not good intentions. Free cash. How much money is available to service debt after all the other bills are paid. This is the key factor behind every credit application, from a car loan or home mortgage to an operating line of credit or senior secured term debt. The more free cash you generate, the more you can borrow. When free cash drops, the opposite is true.
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