An Introduction to Reserve Based Lending and the UK Market

by King & Spalding

Reserve based lending (RBL) is a type of financing where a loan is secured by the undeveloped reserves of oil and gas of a borrower. The facility is repaid using the proceeds that derive from sales in the field or portfolio of fields in production.

RBL market standards contrast between different upstream markets in terms of the acceptability of asset categories, gearing, lending structures and security packages. Divergences in the aforementioned are dictated by the market in question, the history of the market (for example, the lenders which first entered the market and the model structure that was adopted), how advanced the legal framework is in the market, the nature of security and, for the purposes of syndication, the liquidity of the market.

This note considers the key basic structure of RBL and the features of the RBL market in the UK.

Basic Structure of RBL

In a basic RBL structure, assets are ring fenced to provide the lender with security for the facility. The lender advances the RBL facility when they have carried out legal, financial and technical due diligence. Technical due diligence is fundamental and it was US lenders that were among the first to recruit engineers to produce detailed forecasts, based on an estimated value of available reserves and other economic and technical factors.

In RBL, the term of a loan is typically shorter than the expected production life of the reserves and devised according to a production regime. Typically, financial ratios and models are made against certain base cases which are variable, meaning that if a cash surplus exists, there would be a provision to apply the surplus against the outstanding loan.

Although RBL has some similarities to traditional working capital asset-based lending facilities there are some key differences, including the unilateral discretion given lenders to revise commodity pricing assumptions and other assumptions in order to value the reserves and to set the credit limit.

Origins and development of the UK market

The RBL loan market in the North Sea has its origins in large project financings by majors and large independent oil companies in the 1970s. However, in recent decades UK banks have become increasingly prepared to lend to smaller sponsors.

Historically, lenders making loans to major and large independent oil companies have done so on a limited recourse basis whereby they benefitted from parent sponsor, investment grade guarantees which remained in place until a project had started producing. At this point the guarantee would fall away.

A key development in the RBL market in the UK has been the emergence of independents and their use of RBL to finance their portfolios. In these projects, due to the limited value of a sponsor company outside of the project, from day one of the loan a lender takes reservoir risk on undeveloped reserves.

The UK market in contrast

As opposed to the US regime, in the UK lenders are not able to directly take security over physical reserves in the ground and so must take security over contractual rights under an oil and gas license, a production sharing agreement, or a joint operating agreement.

The area of decommissioning cost management is another unique feature in the UK and is yet to be widely adopted in other markets. Decommissioning has grown in importance in the North Sea by virtue of the provisions of the Petroleum Act 1998 (as amended by the Energy Act 1998). To ensure effective decommissioning, the Secretary of State for Trade & Industry has the ability to require an oil and gas license applicant to provide evidence that it is able to fund its future decommissioning obligations. This may be achieved through evidence of the applicant's financial information, including management accounts and decommissioning cost estimates and future revenue predictions. Concerns over an applicant's ability to cover its potential obligations may require additional security to be provided, in the form of decommissioning guarantee insurance, letters of credit, or a sinking fund.

Legal factors worth considering

Whatever the market, there are a number of legal issues that must be considered as a sponsor or a prospective lender in a RBL setup. The issues include taxation, security, bankruptcy, environmental, and importantly the issues surrounding title, ownership and possession. The licensing regime is critical. Oil Prospecting Licenses, Oil Mining Licenses, Production Sharing Contracts, and Service Contracts all require different approaches and create unique issues that must be taken into consideration.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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