When an oil and gas company is over-leveraged and needs to restructure its debt, the typical option that most companies look at is converting all or a portion of its debt to equity via an in-court or out-of-court transaction. While this is the preferred choice, there are other alternatives that can be just as effective. One such alternative includes converting debt to an overriding royalty interest (“ORRI”) that pays the converting debtholders a percentage of revenue based on production over the life of the field asset.
This ORRI structure provides several benefits for both the company and the lender:
- Deleverages the business without changing control of the business.
- Allows equity sponsors to stay in the game and for new money to potentially be put into the business to develop the asset or for other corporate purposes instead of paying debt service.
- Ties future payments to lenders to asset production and market pricing rather than fixed interest payments to improve liquidity in downturns or when wells are temporarily shut in.
- Cost-effective means to restructure as less documentation is required for the transaction and can be done out-of-court.
- Provides alternative income stream to lenders in lieu of interest payments for converting their debt.
- An option if lenders don’t want to hold equity in the business.
- Limits liability to lenders for plugging and abandonment (“P&A”) liabilities as no chain of ownership.
- Good alternative in a poor market when assets may not be able to be sold or would be sold at a heavily depressed price.
- Provides a steady stream of income and still has some upside in the event market pricing becomes favorable.
Generally, this type of restructuring is most likely to be successful when there’s a small number of parties in the lender group, the company holds a high percentage of its well interests, the assets are not readily saleable and ownership of the company isn’t preferred by the lender group.
An example of a successful restructuring where an ORRI was provided to the lender group as part of an out-of-court restructuring is Renaissance Offshore LLC (“ROS” or “the Company”). ROS is an offshore E&P company operating in 16 fields in the Gulf of Mexico, which during the pricing downturn in early 2020, had to restructure its ~$115 million of secured debt due to liquidity concerns.
While most of their peer companies sought Chapter 11 relief, the Company, in concert with its advisors (Opportune operated as a financial advisor), was able to convince its lender group that an ORRI was their best option in the depressed market environment. The nature of its assets, a tough market for asset sales and a willingness to provide new money to improve liquidity, all combined to provide the Company a platform to negotiate an alternative deal structure that would work for all parties.
“While not a conventional form of restructuring, lenders and oil and gas companies need to consider the ORRI model as a potential option as it can be very beneficial to both parties in an industry downturn.”
While not a conventional form of restructuring, lenders and oil and gas companies need to consider the ORRI model as a potential option as it can be very beneficial to both parties in an industry downturn. This is especially true when there could be temporary well shut-ins and significant P&A liabilities for the field assets. Lenders should consider this option when holding equity isn’t preferred or funds may not allow for it as an ORRI still provides a potential steady revenue stream, as long as field assets are producing.