The significant factors in oil and gas loan evaluation have been shifting in recent years. Although reserve analyses and their associated production rates remain basic to an analysis, the economic factors of pricing may frequently involve a greater sensitivity to loan safety than reservoir interpretation.
This paper comments on these changes and on the problems of political risk. A plea is made for realistic evaluations and a political risk. A plea is made for realistic evaluations and a recognition that problem credits hurt the borrowing institutions as well as the lenders.
For nearly fifty years the oil and gas industries have been heavily dependent on the banks and other financial institutions for the credit support necessary to fund their ongoing activities. Today the credit markets are supplying at least 40% of the funds used in the capital expenditures of the industries. This relationship has been mutually beneficial to the banks and the industries ever since the establishment of effective prorationing laws in Texas in the early 1930s. The ensuing stability of price and production permitted the financiers to establish long term credits for the industry with an assurance of repayment over a reasonably estimated time period.
Key to this availability of credit is the confidence of the financial organizations in their ability to evaluate their borrower's asset base and its related cash flow. The responsibility for this evaluation falls on a relatively small group of technicians, principally petroleum engineers and geologists. They exist both in the lending institutions and the consulting firms which serve both industries and they are as frequently the despair of their credit officers as they are of their borrowers. However, their task is vital to the healthy development of our natural resources as well as the prudent allocation of depositors' and investors' funds.
The task facing these engineers has never been simple, although some of us who gained our gray hairs through age as well as work assignment can look back wistfully to an earlier time in the fifties and sixties when there seemed to be fewer variables to vex us. It is to this increase of complicating elements that we would like to direct this paper, and to assess the evolving factors and attitudes which require new adjustments and techniques without, we hope, compromising our basic standards of prudent investment. Because we are bankers we will speak from their position. Most other sophisticated lenders recognize similar standards and procedures. procedures. The area of concern to us is in the subtle shift in significant factors involved in bank oil and gas lending that has developed over the last ten to twelve years. Prior to that time our efforts were mainly concerned with the physical elements of reserve determination and production. Careful judgment has always had to be applied to the interpretation of the supporting data and its application to the determination of the amount and rate of production of recoverable reserves. We were usually able to enjoy production of recoverable reserves. We were usually able to enjoy the benefit of some production testing and frequently even some history, but the decisions as to drive mechanisms and recovery factors could be extremely gutsy. My contemporaries will recall the initial excitement and subsequent dismay over the development of the West Texas Spraberry Trend in the early 50's. At that time the industry was frantically developing the Spraberry formation on 40 acre spacing and completing wells with allowables of 100 to 200 BOPD. Since the trend ultimately covered a couple of hundred square miles, it was no small beer of a play, but it suddenly went flat when the wells' production rates dropped from allowable levels to ten BOPD or less within six months. We learned much about fracture porosity, capillarity and water imbibition from that experience, but at a rather bitter price for some of the oil companies and financial institutions involved.
