The key difference between a traditional lending approach and a project-oriented lending approach to financing independent oil and project-oriented lending approach to financing independent oil and gas producers is the stage at which the lender is willing to enter the project. A project-oriented lender must have the technical expertise to assess enhanced reservoir risks associated with financing oil and gas production prior to the minimum six months production history-normally required by traditional lenders. In production history-normally required by traditional lenders. In return for taking greater than traditionally acceptable lending risks, a project-oriented lender should receive an equity risk type of reward in addition to the usual interest rate on funds provided to finance the project. Although such a lender is knowingly accepting greater than usual reservoir risks, a careful analysis of the sponsor/operator's financial condition, a proper structuring of the loan, and exercise of good Judgment about management's technical and planning capabilities, can help reduce the overall risk to the lender. This paper presents an approach to project-oriented lending to U.S. independent oil and gas producers. project-oriented lending to U.S. independent oil and gas producers.
The following principles of project financing would not normally be thought to apply to the independent oil and gas producer: producer:
the lender's sharing reservoir risk with the borrower and, in exchange, receiving an equity risk type of reward, such as an equity kicker in the form of an overriding royalty interest or a net profits interest. Essentially, the basis of project financing lies in striking an equitable risk/reward profile for all parties to the venture;
assumption that the project's sponsor has a strong enough balance sheet to support a project in its pre-completion stage;
structuring a repayment schedule to require 100% dedication of cash flow, after operating costs, to debt service, so the lender is assured of repayment prior to the investor's receipt of any cash from a project.
In today's lending environment, a bank would normally make a secured loan to an independent oil and gas producer based on the bank's engineer's assessment of proved, producing properties. Typically a bank would lend approximately 50% of the discounted present value of the cash flow from producing properties, with present value of the cash flow from producing properties, with costs and revenues calculated at some reasonable rate. Another approach is to project the undiscounted cash flow from producing properties, escalated based on reasonable pricing assumptions, then properties, escalated based on reasonable pricing assumptions, then offset against this a schedule of principal repayments and a realistic interest rate, requiring that at least half of the total cash flow remains after full repayment of principal and interest.
There are, of course, risks inherent even in this relatively conservative approach to lending to independent oil and gas producers. producers.