Hedge or die, bankers tell small oil firms

LONDON Wed Oct 12, 2011 1:20pm EDT

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LONDON (Reuters) - Energy bankers are telling small oil companies they will soon face a spike in funding costs and should therefore hedge through selling oil not yet produced to protect future cash-flows and survive.

"We are saying to people: You need to be creative and look at other sources. The IPO market is not a place where, if you are a small company, you can find funding," Morgan Stanley's co-head of the oil and gas group, Michael O'Dwyer, told an annual Oil and Money conference.

Banks have been facing a drought of merger and acquisition activity this year due to severe asset price volatility and are looking for new ways of doing business -- including through providing hedging services -- while they also face a higher regulatory burden.

Banking sources say big clients are not asking for banks' hedging services but that small companies with production costs close to the current oil prices are increasingly seeking to mitigate risks through hedges.

O'Dwyer said he has told small companies, "Ultimately you have to consider selling yourself as a company. If you don't have the balance sheet to finance your project, someone else will."

He said other options included a farmout, in which an oil company sells a small stake in its assets, or hedging through selling Brent oil futures.

"Oil prices are discounted in share prices far below the forward (Brent) curve. If the market is not giving you credit for $100-$110 oil, why not monetize it?"

Standard Charter's managing director for Global Energy, John Martin, said he was also witnessing a slowdown in merger and acquisition deals.

"One of the hindering factors is commodity prices. At these price levels, companies aren't rushing to sell assets."

Robert Maguire, a partner at Perella Weinberg Partners, said owners of small firms find it difficult to sell because they still remember their assets being valued higher earlier this year, when oil prices peaked.

BASEL III AND FUNDING COSTS

O'Dwyer, Martin and Maguire all warned that the oil industry will soon face a spike in funding costs.

"One should remember that equity markets are closed for banks ... Oil companies don't understand how those regulations are changing the (banking) industry," said Martin.

All three bankers said pressure on banks to recapitalize, partly to meet tougher Basel III capital adequacy rules, will rebound on the oil industry by constricting banks' lending ability.

"Smaller companies will face a greater impact of increased cost of debt," said Martin.

He said the trend was especially worrying at a time that the oil industry's combined upstream capital expenditure programs are set to exceed $500 billion for the first time ever this year.

The amount is likely to rise further in the years to come as major investments planned in countries such as Australia and Brazil stretch infrastructure and industry resources and continue to drive up costs across the world.

Maurizio La Noce, chief of Mubadala Oil and Gas, which manages $46 billion in assets on behalf of the government of Abu Dhabi, said cash-rich companies might decide to delay acquisitions by at least another three to six months to get a clear view of where financial markets are heading.

Hopes that investors from the resource-rich Middle East will snap up assets are also unfounded, because they have to deal with problems inside their own countries amid mounting unrest.

"(In the Middle East) there is a lot of pressure to build, rebuild, improve the infrastructure, to expand job creation in the countries and the local economies, rather than going outside," La Noce said.

(editing by Jane Baird)

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