Cochran, R.J., Citicorp (U.S.A.)
The concentration of assets in hydrocarbon financing is critical in the determination and elimination of risk associated with this form of financing. It is the purpose of this paper to present a method to define this risk, to measure its degree of severity and to illustrate methods of diminishing this risk to the lender and the borrower.
The risk associated with concentration of assets is that the increasing loss of the major asset will result in a financially untenable situation for the lender and borrower. Therefore, it is necessary to recognize this concentration, measure its magnitude and take steps to prevent its creating a problem for the lender and the borrower.
In the practice of financing, the ability to pay the borrowed money back is a primary criteria in lending. In energy lending, this is also true; the wherewith to repay is the oil and gas derived revenue and assets of the borrower. Therefore, any substance which affects this ability is a factor in the lending procedure. These factors then can be the magnitude of the assets, their anticipated rate of conversion to cash (including government influence, i.e. taxes, prices, proration, restrictions and interruptions by proration, restrictions and interruptions by nature, and business agreements) and the concentration of these assets which can be influenced by any one of these factors. Therefore, it is important in the analysis of a financial transaction involving an energy firm to be able to determine the degree of concentration of the assets. This paper is intended to illustrate a method to determine this degree of concentration in a simple and easy manner.
The benefit of being able to identify the degree of concentration and quantify it will present a situation such that events which change present a situation such that events which change the degree of influence of the governing factors can be compensated for, thus preventing critical situations for the parties involved.
This section presents this method of analysis of the concentration of assets. At the end of the section, several actual examples will be illustrated.
In the normal practice, the data presented to the bank has been processed by a third party, the consultant petroleum engineer. This data is usually ranked by a unit (field, lease, well, etc.) in descending order, or larger to smaller, either on the basis of future net revenue or present worth of the future net revenue. The method present worth of the future net revenue. The method to be illustrated can be used with any of these units as long as consistency of units is used.
The present industry practice uses the 80% value in 20% of the units theory. This says that you have normal distribution of the samples investigated. This is used to investigate the spread of properties/values by both the financial industry, the seller and purchaser. In addition, this is usually the desired cutoff point of "due diligence" investigations by involved parties.
The basic thesis of the illustrated method is a comparison of the to be evaluated data; the "norm" or normal distribution situation. This is to be done by a ratio method which should be easily applied with normally presented data.
The data to illustrate the method will be presented in three forms: presented in three forms:
normally distributed units (Figure 1)
askewed distributed units (Figure 2)
equally distributed units (Figure 3)