RBL: driving spending with lending

Eran Chvika, Norton Rose Fulbright LLP, Paris, explains the importance of reserve based lending for funding oil and gas projects.

Reserve based lending (RBL) is a flexible method of financing that is attractive for both lenders and borrowers, in which availability of funds is based on the value of oil and gas assets of the borrower as revised from time to time.

Lenders may limit their risk by linking facility amounts to the net present value of one or several of such assets (whether or not currently producing), which corresponds to the difference between the present value of the amount of oil and gas that could be recovered and the project costs. The attractiveness for the lenders is linked to the fact that the risk associated with the volatility in commodity prices/market values for such assets is mitigated by the flexibility of a reserve based loan and lenders may continually adjust loan parameters either upwards or downwards to maintain adequate loan-to-value and cash flow coverage ratios to take into account a borrower’s activity (e.g. increase/decrease in oil and gas production).

For oil and gas companies who are either in a development phase in which production is imminent or already producing oil and gas and need to fund expansion, RBL provides an attractive and elastic financing tool in which amounts available are determined by expected production. Repayment of the debt stems from the revenue derived from the sale of the oil and gas, rather than from immediate balance sheet strength.

The RBL loan market has its origins in the US in large project financings by majors and large independent oil and gas companies in the 1970s. In recent decades banks have become increasingly prepared to lend to smaller to medium-sized sponsors in emerging markets who lack the same access to corporate loans as the majors.

The RBL market has expanded over subsequent decades across the globe and there is currently an increase in the demand for the use of such financing techniques. However, market standards continue to vary considerably between jurisdictions such as the North American and UK markets, in which the practice is highly developed, and other jurisdictions such as countries in Sub-Saharan Africa, in terms of acceptable asset categories, lending structures and security packages.

RBL financing is fundamentally different from other financing tools primarily due to the producing nature of the reserves and the variation of the facility amount, which is calculated on the basis of the expected net present value of future production from the fields, or the ‘borrowing base.’ Regardless of the geographic location of the relevant market, there are a number of key issues that must be examined both by sponsors and prospective lenders. These issues are considered in this article.

Fluctuating facility amount

The facility amount is based on the borrower’s working interest in one or more upstream assets and is generally equal to a discounted amount of the net present value of the borrower’s future income from oil and gas developments in such assets.

The size of the facility is periodically determined by valuation of the reserves made by technical consultants based on economic/financial criteria and in particular on well-established production performance derived from volumetric, comparison with similar reservoirs, a computer simulation of new producing zones given lesser weight, geologic conditions as sand continuity, reservoir energy and revised commodity pricing assumptions. As the borrowing base is therefore keyed to such valuations, forecast and redetermination provisions are highly negotiated in RBL financings. The borrower and lenders are permitted to review and object to any forecast under the RBL documentation in a revised forecast, which is resubmitted for review.

The amount of the facility will be increased or decreased by the addition or removal of qualifying assets at the borrower’s request or to meet mandatory prepayments due to a fall in the value of such assets.

In the event that the amount of the facility exceeds the value of the assets, there is a cancellation of the commitment in excess of the relevant value and a mandatory prepayment of outstandings in excess of value will be required, with any failure to make such prepayment potentially triggering an event of default.

By contrast, if the value of assets exceeds amount of the facility, the lenders should increase the available facility amount by such excess.

RBL specific covenants

Although RBL has some similarities to traditional lending facilities there are some key differences, including the discretion given to lenders to revise commodity pricing assumptions in order to value the reserves and to set the credit limit in the course of the life of the RBL loan, which is generally shorter than the expected production life of the reserves.

For instance, several banks made available a short-term, two year crude oil pre-export facility to a significant Nigerian independent oil producer, when it accessed the international market for the first time. The purpose of this facility was to invest in existing production and assist with payments due in respect of new licences awarded to this company. The amount of the facility was based on the banks’ assessment of the reserves in the field operated by the company and the production and price curves over the life of this term facility.

RBL documentation typically includes several covenants to address specific lender concerns similar to those found in other financings, such as financial covenants, restrictions, specific cash waterfall provisions, prohibitions on additional indebtedness and distributions. It also includes borrowing base deficiency provisions. The borrowing base deficiency can be cured by the borrower adding additional oil and gas properties to the collateral base; alternatively, the lenders can agree to graduated reductions in available lending commitments.

The RBL documentation typically allows debt levels/amortisation to be either increased or decreased to levels that maintain loan-to-value and cash flow coverage ratios that take into consideration changes in cash flow caused by acquisition, increase/decrease in production, operative costs or drilling activity since the last redetermination, any of which could impact the expected ultimate recoveries of reserves.

Bank legal counsel will also review/evaluate the borrower’s title to its oil and gas properties to verify that it matches the net revenue interest reflected in the technical consultants’ reports and forecasts.

Lenders require that the oil and gas entities further provide a number of financial documents and specialist reservoir engineers’ analysis on a regular basis, or to be notified of the occurrence of certain events (e.g. any force majeure event affecting the borrowing base asset) in order to enable them to monitor the increase/decrease of production and the financial situation of the oil and gas entity generally and the ability of the such entity to comply with the obligations under the RBL loan.

The lenders will further require the oil and gas entities to provide a number of specific covenants in the RBL loan agreement regarding the manner in which they carry out their business in order for the lenders to have a degree of control over such activity and management, such as key-men provisions.

A breach of any of such covenants may lead to an event of default and give to the lenders the right to accelerate the RBL loan.

Security package

Lenders normally require at least 80% of the initial collateral value to be covered by a perfected security interest and to have clear title under the security package.

A key legal consideration for any lender seeking to take security will be the licensing regime under which the borrowing base assets are operated. In many jurisdictions, it is not possible to take security in favour of the lenders over the underlying physical reserves themselves while they remain ‘in the ground’ since these are often owned by the host country rather than by the operator, who therefore cannot grant security over such reserves as it lacks the necessary title over such reserves to do so. In such a context, obtaining acceptable security over the reserves themselves would require the host government to grant advance approval to the assignment or transfer of such title in certain circumstances, a daunting prospect which may be difficult and time demanding to obtain.

For such reason, lenders generally look to other forms of security, such as assignments or pledges of contractual rights arising, for example, under an oil and gas licence, a production sharing agreement or a joint operating agreement and negotiate a suitable security package in line with the local legal framework and market practice.

Generally, a pledge over the shares of the borrower oil and gas entity holding an interest in the licence is considered as the security option of choice since it enables the lenders to take over such company upon the occurrence of an event of default and the enforcement of such pledge.

The assignment of key contracts is also often part of any security package and includes an assignment of the borrower’s rights, including any receivables due.

A pledge over the borrower entity bank accounts, in addition to a detailed bank accounts agreement, provides further comfort to the lenders in order to have adequate control over cash flows arising from the relevant borrowing base.

Many oil producing jurisdictions in sub-Saharan Africa are member states of OHADA, an organisation created by treaty for the harmonisation of business and commercial law in Africa. OHADA has promulgated a number of uniform laws, which, upon approval by the Council of Ministers, are automatically applicable in each of such member states. Recent modifications to the OHADA Uniform Act on Security Interests and the OHADA Uniform Act on Commercial Companies have resulted in a modern and sophisticated legal regime for the taking of security interests in a RBL context, including the ability to grant all security to a single security agent, an effective means of creating a security assignment of commercial receivables despite any contractual provision to the contrary, specific provisions permitting both outright cash collateral by way of transfer of title to the cash and pledges over outstanding balances from time to time of charged bank accounts, streamlined procedures for creating security over tangible fungible assets, company shares and receivables and, most critically, the ability to enforce most forms of security by outright transfer of the pledged assets to the beneficiary of the security (pacte commissoire), subject only to subsequent expert evaluation and the return of any surplus value of such assets over the secured debt to the security provider.

Nevertheless, it should be borne in mind that the legal framework of oil and gas exploration and operation of each OHADA member state remains a matter for its own legislation, and that the ability of borrowers in such jurisdictions to open and maintain bank accounts outside the relevant jurisdiction and their obligations to repatriate in-country the proceeds of sale of offtake into foreign jurisdictions will be subject to exchange control rules, either on a national level or those promulgated by west or central African central banks pursuant to regulations promulgated by regional monetary and finance unions.

It should also be noted that, although RBL is generally a technique of leveraged financing that involves lending on a non-recourse basis, in certain transactions lenders require a parent company guarantee securing the obligations of the asset holding company under the RBL loan.

Furthermore, where borrowing bases consist of assets owned by several entities within the same group, lenders may, subject to local guarantee restrictions, require each asset-owning entity to cross-guarantee the debts of each other entity and the liabilities to be secured by each of their assets.

There are therefore a number of differences between standard financing methods and RBL financings. Precedents do not set out the boundaries and lenders, borrowers and their advisers need to work together to create tailored made solutions to address those differences in the negotiation and documentation stages of a RBL setup.

Adapted from an article in the October issue of Oilfield Technology.

Read the article online at: https://www.oilfieldtechnology.com/exploration/17102014/rbl-driving-spending-with-lending/