Colin Butcher Managing Director, Oil and Gas, Lloyds Bank

Colin Butcher, Managing Director, Oil and Gas, Lloyds Bank

Q: What are the three main challenges that energy-focused CFOs face in todays markets and how can they overcome these?

A: The biggest challenges facing companies in the oil & gas sector over the short to medium term are funding, counter-party risk and cost inflation.

Funding

Capital is more constrained because banks need to hold higher levels ahead of stricter requirements being implemented in the form of Basel III and domestic bank capital adequacy rules. This has increased the cost of capital. Funding for O&G companies in the bank market has held up well, but equally pricing is going up. Liquidity for the O&G sector remains adequate, which includes liquidity in the RBL market.

Debt capital markets are being seen as an alternative funding source for those companies that have access. As government bond yields in “safe haven” countries such as the US, Germany and the UK hit record lows, investors are looking to the US private placement and public bond markets for a pick-up in return while still maintaining an acceptable level of risk. Demand in the sterling and dollar markets has been strong through 2012 and this looks set to continue. Lloyds Bank has a track record of successfully taking customers to these markets to diversify sources of funding and extend tenor.

On the face of it, the latest effort by the UK government to stimulate lending – the Funding for Lending Scheme (FLS) – looks like it could have a limited impact on the O&G sector with US dollar funding needs. However, for UK businesses with UK assets, Lloyds Bank can structure deals to enable customers to take advantage of the scheme.

Counterparty risk

Corporates are spending more and more time assessing the stability of their banks. Bank credit ratings have fallen across the board and some O&G companies now have higher ratings than the banks funding them. A systematic approach to measure counterparty risk is necessary to evaluate potential funding or bank service issues. This approach should not only take ratings into consideration, but also systematic importance, shareholder structure and funding base. The eurozone debt crisis continues to rumble on and banks’ exposure to this region should be a consideration as well. Lloyds can offer its clients analysis of their counterparty risks and advice on how to implement a systematic evaluation framework.

Cost inflation

The costs of both building and operating upstream oil and gas facilities continue to rise significantly - roughly in line with longer term oil price movements. These cost increases have an impact on budgeting, cash management and contingency planning. It is important to ensure that flexibility is built into financing packages to allow cost increases to be managed by the business.

At Lloyds, we can offer a variety of ideas and products to help mitigate price movements of some of the components through hedging structures.