Energy: opportunity and exposure

After over five years of oil prices at around $100 a barrel, the commodity’s swift fall in price to under $50 a barrel has distressed investors salivating over the potential opportunity.

“We’ve argued for a few years that credit standards were dropping as investors—chasing yield—became less disciplined and less discerning. But we knew great buying opportunities wouldn’t arrive until a negative ‘igniter’ caused the tide to go out, exposing the debt’s weaknesses. The current oil crisis is an example of something with the potential to grow into that role,” Oaktree Capital Management’s Howard Marks wrote in his December investor letter.

Oaktree is already raising a $10 billion distressed fund.

Avenue Capital’s Marc Lasry is even more convinced of the opportunity, so much so that the firm is raising a $750 million Avenue Energy Opportunities Fund, its first energy-focused distressed fund.

Avenue will look at over-levered borrowers reliant on $100 a barrel oil. Both the Brent and WTI crude benchmarks fell to under $46 a barrel in the days before PDI went to press.

Lasry anticipates a price recovery in the $70 to $90 a barrel range in two years.

So not only can investors profit on the eventual rise in oil, but they can also convert their debt investments into equity, he told CNBC’s Squawk Box in January.

Those smelling opportunity have already moved in. GSO will invest $500m in LINN Energy, a Houston-based oil and gas exploration company. The facility is structured as reverse convertible debt.

GSO will provide $500 million to finance a drilling program. The Blackstone-owned firm will fund 100 percent of the costs associated with specific wells in return for an 85 percent working interest. If its 15 percent annual IRR return target is achieved, GSO’s working interest drops to 5 percent.

Resolute Energy Corporation also entered into a deal with Highbridge Principal Strategies at the close of 2014. Highbridge is providing a $150 million second lien secured term loan which pays an interest rate of 10 percent over LIBOR and channels up to 75 percent of the proceeds of any asset sales to debt repayment. It also amended its senior revolving credit facility, adjusting the valuation of the underlying assets and re-writing the covenant package to match that of the new debt.

Although many credit managers have refused to comment on their energy exposure and how it has been affected by the fall in oil prices, sources tell PDI that, BDCs are frequent energy lenders.

Overall, 2014 was a difficult year for BDCs; the share prices of many suffered early in the year.

Some, like Fifth Street Asset Management, have already come out with statements saying they reduced their energy exposure in the fall.

While oil is still down, selling out of deals is a bad idea, several sources said, and lenders with oil and gas exposure will wait it out. The impact of the commodity price fall will become clearer when they report their fourth and first quarter earnings.

BDCs with more than 10 percent of their portfolio in energy or oil and gas investments include Apollo Investment Corporation, BlackRock Kelso Capital and THL Credit. Main Street’s portfolio comprises 8.4 percent energy equipment and services and another 1.9 percent in exposure to oil, gas and consumable fuels, as of 30 September 2014.

The volatility may have distressed investors rubbing their hands, but it’s unequivocally bad news for US mid-market lenders.  n