Oil exploration and production companies are not short of options when it comes to financing options. To bolster the pot of money on which they can draw from to fund a new project or expand an existing operation, they have a wide range of choices. An upstart explorer looking to step up to the big leagues, can opt for an IPO or turn to deep-pockets of private equity, an established player can borrow against its existing reserves and a company looking to sharpen its focus can look to divest its non-core assets and put the proceeds to work on its core.
Each of the aforementioned funding mechanisms, and the majority of the others open to the industry, rely either on the company using its own assets to secure funds or receiving investment from institutional investors. Now though, a small number of companies have started to turn their attention away from the high rise offices of investment banks and pension fund administrators in favour of the simple household.
In 2013, the UK’s largest independent oil exploration company EnQuest became the first company from the sector to dip into the retail bond market for funds. The initial issue by the North Sea operator raised £145 million, with investors putting in a minimum of £2,000 to receive a return of 5.5% until they matured in 2022. Following on from EnQuest, Premier Oil became the second firm to turn to the retail bond market, raising £150 million in capital through 5% bonds that mature in 2020.
Reducing reliance on banks
Commenting on the launch of the bond issue, Simon Lockett, chief executive of Premier Oil, said: "We are delighted to announce the launch of Premier’s debut sterling bond which will enable Premier to diversify its sources of debt finance." Taking a similar tack, EnQuest CFO Jonathan Swinney, said: "When you have long-term projects you don’t want to be beholden to the bank market, so diversifying fund is important."
In terms of why a company from the oil and gas sector finally decided to dip into the retail bond market, David Reitman, corporate finance partner at KPMG, suggests that there has been a perfect storm: "We’ve had the most extraordinary set of circumstances. We’ve had a real credit crunch, we have had a drying up of traditional sources of liquidity, which has now come back, but the background to that is that we’ve had an unbelievably low interest rate environment. All of that has created a perfect storm for something like the retail bond market to evolve and to flourish."
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Cheaper form of funds
According to Joel Dungate, investment analyst at Redmayne-Bentley, which worked on the Premier Oil bond issuing, the retail bond route offers a cheaper alternative to a bank loan. He says: "These bonds offer a relatively cheap form of finance and do not dilute existing ownership of the business as offering shares would do. This form of funding helps to diversify a company’s source of borrowing and reduce dependence on, for example, bank finance."
He adds that there has been particularly strong demand for retail bonds during the current environment of low interest rates: "There is currently strong demand for retail bonds from investors due to interest rates remaining low which means they are not getting the return on cash deposits that they used to historically."
As Jason Fox, senior partner at law firm Bracewell & Giuliani explains, pitching to retail investors instead of institutional investors, enables a firm to offer a lower interest return: "A key attraction of retail bonds for the issuer are the potentially low rates of interest that retail investors will accept compared to institutional investors. Fox also identifies comparatively "long maturities" and "ease of issuance" as further attractions.
As with all funding arrangements, retail bonds carry significant risks to the issuer, as Fox explains: "For the issuer, one risk is that the issuer’s situation may change making it difficult to comply with the bond terms. Securing waivers of bond terms is always far more complex and uncertain than with bank debt."
Potential PR problems
Difficulties can also arise if things for the company go better than expected: "The issuer may find it no longer needs the bonds and wishes to redeem them. This is always possible but, depending on market conditions, can be costly whereas bank debt can almost always be redeemed without premium or penalty," says Fox.
In terms of public relations, the issuance of retail bonds can be used to build stronger links. "They are potentially a way for a company to promote stronger links with customers, if held to maturity, and encourage greater brand loyalty," says Dungate. On the other hand though, if things go wrong, it could lead to a PR disaster, as Fox explains. "If things turn out badly there is a risk of a vociferous general public on the pavement outside your head office."
Asked how big a role the retail bond market might play for the oil & gas industry, Reitman says: "This is a yield driven market so people would have looked at the EnQuest issue and the Premier issue in the context of what else was available at that time. Therefore, if there is a lot of liquidity out there at a given time and a Premier or an Enquest wants to come to market, then it’s difficult to see why they wouldn’t get a good reception in that market."
Fox also believes that retail bonds will continue to be used by the sector, but their role will pale in comparison to traditional routes: "I am sure others will tap this market but they will be very small in number compared to the overall pool of E and P companies who access the debt markets."