The recent bounce in the price of crude that saw it break the psychological US$50-per-barrel mark has given considerable hope to the energy patch and beleaguered Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE) in particular.
Nonetheless, it appears that the recovery in crude may be too little, too late as time is fast running out for the oil explorer and producer.
Now what?
The crucial issue facing Penn West is that it will more than likely breach is financial covenants at some stage during the later half of this year. This is despite the company actively seeking the support of creditors and discussing options with them to prevent this happening.
You see, Penn West was able to renegotiate its financial covenants in 2015, increasing the ratios to 5:1 for its senior debt and total-debt-to-EBITDA covenants. With a ratio of 4:4.1 at the end of the first quarter 2016, Penn West was in compliance with those covenants.
However, the problem is that the covenants will be reset to their original levels at the end of the third quarter 2016 for total-debt-to-EBITDA ratio and in January 2017 for the senior-debt-to-EBITDA ratio. This means these covenants will be reduced to 4:1 and 3:1, respectively, and with Penn West’s cash flows continuing to deteriorate because of weak oil prices and declining production, it is only a matter of time before it breaches those covenants.
In fact, management noted in Penn West’s first-quarter 2016 report that a breach is likely by the end of the second quarter 2016.
Meanwhile, Penn West remains engaged in negotiations with its creditors in order to amend the covenants and prevent a breach, but there are signs that lenders are growing increasingly weary of this. Even if Penn West is able to obtain agreement from its creditors to amend those covenants, it will be forced to comply with a range of stringent conditions that could be even stricter than the last time it was able to amend its covenants.
Any amendments to its covenants does not come cheap.
Last time it was able to successfully renegotiate the covenants it had to grant floating charge over all of its property to its lenders, slash its dividend, and face increased financing costs.
What is worrying is that this time around its creditors may not be so willing to renegotiate the covenants because of Penn West’s deteriorating financial position.
For the first quarter 2016, Penn West’s cash flow deteriorated by 39% compared with the same period in 2015. This can be attributed to declining oil output, which dropped by a worrying 19% year over year for the first quarter.
Furthermore, the total value of assets declined by 5% compared with the end of 2015, and long-term debt remained at over $1.5 billion–a daunting figure for a company trying to cope with low oil prices and declining production.
Now, with Penn West pushing hard to sell assets in a buyers’ market, so it can reduce its debt to a manageable level and survive, production will continue to decline. This certainly doesn’t bode well for the company’s future because it is also failing to make a sufficient investment in exploration and development, which means it is incapable of replacing oil production lost due to natural decline rates.
So what?
The outlook for Penn West is becoming ever more desperate, and with its declining financial and operational position, its lenders may not agree to renegotiate its covenants. This increases the likelihood of it failing and makes it vulnerable to secured creditors pushing for the implementation a capital restructuring that would leave Penn West’s equity worthless in the hands of investors.
