Goldman Sachs Commodity Linked Financing IPAA Conference A presentation by Goldman, Sachs & Co. Commodity Risk Management (212) 902-0776 April 2005
Goldman Sachs Commodities/J Aron • J. Aron is the commodities risk management business of Goldman Sachs and receives the full corporate guarantee of the Goldman Sachs Group (A+/Aa3) • Founded in 1892 and acquired by Goldman Sachs in 1981 • Currently employs approximately 200 professionals globally in 6 regional offices (New York, London, Singapore, Tokyo, Sydney and Calgary) • Voted 2004 Commodity Derivatives House of the Year by Risk Magazine • Recent Business Initiatives • Underwritten or principaled over $6.5Bn worth of commodity liked-financings in the past 10 months • On staff petroleum engineers allow us to take oil and gas reserve risk in derivative and financing transactions • Asset Secured Hedging Facilities • Volumetric Production Payments • Production-Contingent Derivatives • Through GS E&P Capital, over $100MM of development financing commitments to the North American oil and gas industry in 2004
Goldman Sachs E&P Capital • Houston based principal investing effort for Goldman Sachs • Investing Goldman’s balance sheet • 5 energy specialist with 16 years average experience • 3 Petroleum Engineers on staff • Flexibility in transaction structure • Junior and/or Senior Debt • VPPs • Drilling partnerships • Preferred Equity • Flexibility in transaction size • $15mm – several hundred million • Seeking principal opportunities, but can arrange a transaction of any size • Desire to build relationships with follow on investments • Can provide capital markets exit • Flexibility in commodity hedging • Long-term, asset-secured hedging • Elimination of cash collateral requirements
Four Basic Structures for E&P Debt (Debt Like) Investments • Senior Revolving Debt • Corporate debt • Fully secured with financial and asset-based covenant package • Advance rates subject to semi-annual borrowing base • Mostly PDP driven valuation, 1.75 Coverage Ratio • Libor + 125-300 • Typically 2-3 year maturity, no prepayment penalties • May include stretch tranche under same security package • Proceeds available for general corporate purposes • Volumetric Production Payments • Not debt; sale of a real property interest • No covenant package • Operating and delivery obligations often secured by retained interest • Typically 100% PDP with some flexibility to monetize PDNP • Periodic coverage ratio of 1.25-1.75 • Pricing 6-12% • Typically 4-7 year term • No restrictions on use of proceeds
Four Basic Structures for E&P Debt (Debt Like) Investments • 2nd Lien • Corporate debt • Fully secured but subordinated to senior revolver • More relaxed covenant package • 75% PDP, 1.5 Coverage Ratio • Libor + 400-800 • Term debt; 3+ years with prepayment penalties • Proceeds available for general corporate purposes • Mezzanine Debt • Corporate debt • Security and covenant package highly customized • 10 - 50% PDP, 1.5 Coverage Ratio • 8-10% coupon plus some upside participation, 12-15% all-in • Term debt; 3+ years with prepayment penalties • Specific use of proceeds, typically funding of approved drilling program
Energy High Yield Bond Returns Credit spreads have tightened over the past five years as interest rates have declined and commodity prices have increased
Increasing Valuations On a $/boe basis, average acquisition prices paid have grown substantially along with crude prices since 1999
Goldman Sachs Commodity Markets Source: Goldman Sachs
North American Natural Gas Basis Markets Goldman Sachs is a leading financial and physical dealer for swaps and options at these and many other locations. AECO Sumas Texas Eastern M-3 Northwest Rockies Transco Zone 6 Non-New York Chicago Citygate Ventura CIG Panhandle ANR Oklahoma San Juan Southern California Sonat Permian NGPL Texas-Oklahoma Henry Hub Waha Houston Ship Channel Source: Goldman Sachs
Production Payments • Volumetric Production Payment • Nothing new, have been around since the 1930s • Not debt, but the sale of a real property interest • E&P Company sells VPP to financial buyer • Delivery obligation is volumetric; discount rate is not explicitly stated • Underlying instrument is a Term Overriding Royalty Interest • Non-cost, non-expense bearing interest • Property specific burden, recorded conveyance • Seller has ongoing obligations to operate and deliver/market production • Seller must deliver volumes each month • Seller does not guarantee volumes, buyer can only look to specific property for volumes • Typically 100% hedged by VPP buyer • Some limitations on what seller can do with properties
Volumetric Production Payments • Principal factors determining size and pricing • Reserve mix – needs to have large percentage of PDP • Value diversity – no value concentration in a few wells • Periodic coverage – projected volumes available each month compared to volumes required to be delivered • Tail – the amount of reserves expected to be remaining at the termination of the production payment • Regional basis markets and available market points • Seller’s operating capabilities and creditworthiness • Alternative: Dollar Denominated or Financial Production Payment • No delivery schedule, rather buyer receives a fixed percentage of production • Discount rate/IRR hurdle is explicitly stated • Large percentage of production still hedged, but not 100%. • More flexibility in hedge structure • Easier to handle non-producing and undeveloped reserves • Easier to handle two phases (both oil and gas)
Case Study: Volumetric Production Payment • In 2004, GS E&P Capital purchased a VPP for $15mm from a private seller • The VPP burdens long-lived properties in the Arkoma Basin • Goldman Sachs and the Seller arranged for the Seller to market the VPP production on behalf of Goldman Sachs • The price received under the marketing arrangement is linked to an appropriate basis location • Goldman Sachs hedged its price risk financially at closing; seller has no exposure to basis risk (other than physical vs. financial spreads) Volumes LOE VPP Volumes Retained Interest Time
Second Lien Case Study: Belden & Blake Corporation $170.0 million Senior Secured Credit Facilities $192.5 million Senior Secured Notes 1 Up to $15mm of LCs can be issued to support the hedges.
Second Lien Case Study: Belden & Blake Corporation $170.0 million Senior Secured Credit Facilities $192.5 million Senior Secured Notes 1 Pricing on LC facility and revolver can step down to L+250 bps and L+225 bps based on specific leverage levels. 2 Pricing on term loan can step down to L+250 bps based on specific leverage levels.
Current Trends • New money from non-traditional sources • Hedge funds, investment banks; non-energy commercial banks • Chasing yield; rates and credit spreads at historically low levels • Intense competition among capital providers • Private equity in abundance • Lenders willing to lend more and accept lower yield • Traditional mezzanine financing being crowded out by aggressive 2nd lien and private equity capital • Unconventional Gas Plays • CBM, shale gas, tight sands plays offer the scale and risk profile to attract significant capital
Primary Financing Factors for Small Cap E&P Companies • Track record • Operating history, financial performance • Reputation • Size and Nature of Financing • < $10mm; $10mm - $50mm; > $50mm • Specific future growth opportunities available • Is cash flow available to pay current interest, amortize debt? • Use of proceeds • Perceived Risk / Asset Mix • Percentage of PDP reserves • Location (onshore vs. offshore, conventional vs. unconventional) • Nature and potential of growth opportunities • Term objectives • Up to 3 years; 3-5 years; > 5 years • The perceived risk of a given opportunity will vary significantly among capital providers • Private Deals are difficult to benchmark; terms generally not disclosed • Capital providers are forced to rely upon their past experience and inexact comparisons
Contacts • Commodities (New York) • Colleen Foster (212 902 0776) • Simon Collier (212 902 0776) • GS E&P Capital (Houston) • Kurt Talbot (713 658 2680) • John Howie (713 658 2682)
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