American Oil and Gas Reporter - December 2021 - 50

Unitranche Financing
STUART REXRODE
President and Managing Partner | BlueRock Energy Partners
Q:
Do you expect private companies to continue to lead
the way in increased drilling and development activity?
How do you see factors both internal and external to upstream
oil and gas shaping financing trends in 2022, particularly for
smaller privates? What role is unitranche financing (combined
senior and subordinated debt) playing in giving small independents
access to capital to sustain their activity levels
and capitalize on today's market fundamentals?
REXRODE: I do, for at least the first quarter of 2022.
Because the publics are still under pressure to return cash to
shareholders and prove fiscal discipline, I think it will take a
few more quarters before we see significant development activity
from that group. The privates are nimbler and more motivated
to simply take advantage of higher commodity prices without
the added pressure from public shareholders.
I believe this development activity will be funded with
private senior debt and mid-risk capital, given the continued
pullback in the commercial banking segment and muted public
equity markets. Clearly, risk capital, perhaps mezzanine funding,
will play a large role in the small independent segment. However,
I would emphasize alternative credit versus mezzanine as the
key phrase.
With the pullback in reserves-based lending, I believe highercost
private senior debt and unitranche structures (versus traditional
mezzanine) will fill the gap for development capital, as lenders
continue to need a high percentage of proved, developed and producing
reserves. In the past, mezzanine capital may not have
included meaningful PDP production, and many mezzanine shops
got burned in the downturn. I believe that profile has changed
dramatically. Also, I believe most structures will have amortizing
features that coincide with the decline profile of assets being
financed. While BlueRock often gets tagged with a mezzanine
descriptor, we actually are a unitranche capital provider.
Q:
A&D dealmaking rebounded sharply in the second
half of 2021 as the industry upcycle gained momentum.
How can operators leverage nonrecourse financing
to acquire assets? What are the benefits of using nonrecourse
structures versus other forms of financing property acquisitions?
What type and size of A&D deal is most suitable?
REXRODE: Clearly, nonrecourse capital options are available
to operators whereby advance rates against asset purchase price
can be significant, sometimes greater than 90%, depending on
price against reasonable PDP value. That is especially true if there
are attractive development opportunities associated with the asset.
Having said that, the cost of capital will certainly be higher
than traditional bank lending, but the required " skin in the
game " equity will be reduced. Usually, nonrecourse finance is
completely ring-fenced against the specific asset with little to
no guarantees and financial covenants. Again, the fewer hooks
into other assets brings higher cost of capital, but the flexibility
often is the difference in getting the deal closed.
An 8%-12% cost of capital can make a lot of sense when
buying PDP assets for PV12-PV20, with upside available. Non50
THE AMERICAN OIL & GAS REPORTER
recourse financing can work in many situations. However,
amortizing structures that mirror the decline curve of the assets,
whether conventional or unconventional, are most effective
because they best ensure the capital provider is capturing cash
flow from the specific asset being financed, as opposed to
relying on other assets. Assets in the $5 million-$50 million
range work well with nonrecourse structures.
Q:
Operator balance sheets are in materially better
shape than 12 months ago. How are higher commodity
prices and improved borrowing capacities impacting the
market? What kinds of business opportunities and activities
are best suited for unitranche investment structures?
REXRODE: Unitranche combines the senior and mid-risk
capital in one structure. Our transaction is a financial production
payment structured as a temporary overriding royalty interest
that is rate-of-return-driven to maturity, as opposed to a set
amortization timeline. Perhaps as a proxy to mezzanine financing,
our structure is quite attractive to small- to midsized operators
simply because the traditional RBL providers have pulled back
significantly in recent years.
Certainly, bank refinancing opportunities and acquisition
funding opportunities have increased dramatically with higher
commodity prices, as the math in many plays now makes sense.
We are seeing a robust pipeline of opportunities from operators
where RBL lending does not get them the capital amount
needed for an acquisition with the flexibility for additional
capital for development, or simply there are few bank options
available.
In addition, the operator doesn't want to sell down the deal
to equity players and give up potential upside. Moreover, we
are seeing many players with bank facilities that are requesting
to be taken out. Increased commodity prices are allowing many
of these refinancings to make sense, even with additional development
capital layered on top.
Q:
What characteristics do you look for in a management
team? Are there certain types of assets that you
prefer? How does Bluerock partner with clients to ensure
win-win outcomes over the long term?
REXRODE: It is not a secret that most capital providers
want to see an experienced technical team in place with their
clients, specifically in the play being financed. BlueRock is no
different. From the first meeting, it is always clear if the operator
is experienced to take on a project, simply by reviewing and
discussing their technical valuation work product and thesis for
the upside work plan.
And it sounds cliché, but high character in the client principal
is paramount when we consider a financing a client. The past
two or three years have certainly tested the character of many
of our clients with lower commodity prices, and our portfolio
has remained strong because we feel like we have a group of
clients that work with us constructively and do the right thing
when times get tough. We are industry players, and we understand
the oil and gas business can be challenging. We pride ourselves
American Oil and Gas Reporter - December 2021

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