Written by Shankar Ramakrishnan and David French

(Reuters) – Private U.S. oil and gas companies are increasingly turning to a specialized financing structure that securitizes their production, providing a means of financing for producers and owners as traditional sources become more expensive or simply dry up.

Known as PDP Asset-Backed Securitization (ABS), this product takes revenue generated from companies’ proven oil and gas operations, development, and production (PDP) and uses that cash flow as collateral for a bond that is sold to investors.

With pressure on banks by stakeholders to restrict loans to the oil and gas sector because of its environmental impact, private energy producers—who rely more on banking lines than their listed peers—can maintain access to external financing through this specialized product.

“This product resonates with private exploration and production companies that have relied primarily on handguns from commercial banks, but the availability of such financing has declined,” said Daniel Allison, partner and energy specialist at law firm Sedley Austin LLP.

While the first-rated PDP securitization was completed in September 2019 by Raisa Energy, volatile commodity prices and a wave of producer bankruptcies in 2020 hampered the initial application. However, in the past year or so, as commodity prices hit multi-year highs in 2022, companies and investors are increasingly taking notice.

More than $3.9 billion of energy-related ABS were sold in the public and private markets in 2022, compared to $1.2 billion in 2021, according to Guggenheim Securities. The investment bank helped, among other things, arrange the $750 million ABS that Jonah Energy sold in October — the largest securitization currently completed in PDP.

One such adopter is PureWest Energy, Wyoming’s largest producer, which sold two such deals: a $365 million paper in August, following a $600 million issue in November 2021.

Ty Harrison, PureWest’s chief financial officer, explained that PDP’s securitization ring fences off oil and natural gas wells so that the cash from them goes to debt service. A robust hedging strategy ensures that movements in commodity prices do not inhibit the ability to pay investors.

A fenced bond typically carries investment-grade ratings, which means energy producers, which can be rated junk, can raise money at lower costs: the interest rate is roughly 2 to 3 percentage points lower than traditional alternatives such as term loans or loans, Harrison said. The high-yield bonds.

There are also pricing advantages for investors, most commonly insurance companies, said one investor who did not wish to be named, since these PDP ABS pay at least 100-150 basis points more than comparable comparable corporate bonds with an investment grade rating.

growing appeal

In addition to financing day-to-day operations, private equity firms that own energy producers are exploring the use of PDP securities as a payday investor.

The attraction stems from the inability of acquirers to sell or list companies at a better valuation than simply collecting profits from rising commodity prices. The securitization effectively collects profits and distributes them to investors as a temporary bonus, allowing owners time to find another exit during the life of the ABS—usually three to five years.

Power Partners is one example. It is currently pursuing an ABS deal, after Reuters reported in May that owners Kayne Anderson Capital Advisors and Warburg Pincus were trying to sell the company.

“There will be more such deals in the future as private equity holders look to liquidate assets that have not achieved a reasonable sell valuation,” said Pete Bowden, global head of industry, energy and infrastructure at investment bank Jefferies.

The PDP ABS product is not for everyone: it requires oil and gas wells to produce at a consistent pace with low drop rates, which are typically older drilling sites. New shale wells have intense initial production, as hydrocarbons are released through the hydraulic fracturing process, before rapidly imploding.

Sidley’s Allison said there is plenty of appetite among those whose production is viable: half a dozen companies have approached his company this year to arrange PDP securitizations, with several others in early-stage talks.

“We will see further growth in the issuance of ABS next year, as upstream companies increasingly exploit the market as an important component of their capital structure,” said Cory Wishingrad, head of fixed income at Guggenheim Securities.