Lending to an oil and gas producer requires a fine blend of both credit and technical analyses. The primary asset, and often the only asset is oil and/or gas in the ground. A loan to the producer is dependent on the valuation of these assets. Determination of reserves is necessary, but more often than not, of greater importance is the rate of production of these reserves and the corresponding cash flow. Wells may be capable of producing at rates greater than pipeline capacity or higher than the ability of the economy to absorb the production. With the technical and economic analyses, a thorough financial review is necessary.
Natural resource lending was the darling of the banking industry during the seventies and early eighties. The natural resources or energy group within a bank provided significant earnings. As this became evident, other banks jumped into this area of lending. Some of these banks were ill equipped for this type of financing. As competition increased, interest rates were lowered and lending practices were liberalized. Now with the collapse of Penn Square and the losses other banks have incurred on production loans, loans to oil and gas producers production loans, loans to oil and gas producers are subject to increased scrutiny. In many cases, the small producer is finding it nearly impossible to obtain a loan. To alleviate this problem, an educational process must begin. An initial requirement is an adequate staff of knowledgeable personnel. Senior management in the bank must personnel. Senior management in the bank must be provided with background of the industry. Policies relative to how loan amounts are to Policies relative to how loan amounts are to be determined are required. The producer requires an understanding of these policies in order that he may make his decisions. Rapport needs to be established between the borrower and lender.
Adequate staffing is probably the single most important item in energy lending. The measure of adequacy is not in numbers alone. Both the technical and banking personnel must be well trained. The bankers need to be experienced in term lending. They need to have a speaking acquaintance with industry practices and the various terms used therein. Further, an understanding of the accounting practices of the industry is required.
The staff of an energy or natural resource department in a bank will consist of a combination of bankers and engineers. In some banks engineers function as lending officers in addition to making reserves analysis. In others, the engineers function in an advisory capacity to the lending officers. Either organization is effective. But in the case of each, certain checks and review procedures are necessary. Also, it is important procedures are necessary. Also, it is important that there are at least two people familiar with each credit.
Continual training is necessary for both the technical and lending personnel. Bankers and engineers in banking are working in somewhat of a vacuum relative to the oil industry. Technology and processes in the industry are continually changing. It is imperative for the banking personnel to keep abreast of these developments. There are various courses available for the lenders to help in this area. Also, attendance at various conferences is beneficial. The engineers should attend a minimum of one short course and one symposium annually. They should also participate in the local SPE section meetings. Periodic attendance at regional and national meetings are also important.