Financing the Appalachian Oil and Gas Industry

Abstract In recent years, the Appalachian area has experienced a resurgence of oil and gas drilling and development. Increases in prices and the outlook for continued growth in the value of oil and gas has generated this growth in activity. Most of this growth has come from the smaller, independent, operator and contractor. It is these companies who must rely on additional outside capital to achieve their growth. This capital can be generated either from new investors or from debt. This paper will deal with the various methods of securing and structuring debt for these different facets of the oil and gas business in the Appalachian area. For the small, independent oil and gas or contracting companies, which comprise the majority of the business in the Appalachian area, the only available major debt structure is secured lending. Secured lending means that banks will loan money to a company using a part or all of a company's assets as collateral. For a contractor, this collateral is his equipment; for a pipeline owner, it is his pipeline and sales and purchase contracts; and for the producer it is his oil and gas reserves. It is the bank's role, then, to determine (1) the value of this collateral and whether it will generate sufficient cash flow to pay interest and retire debt, as well as (2) the borrower's financial responsibility, character, integrity, business stability and potential, and business relationship to the bank. This latter determination can be established with financial statements, earnings reports, business references, and credit reports. Determining the value of collateral presents a more difficult problem. For equipment, this can be done through an appraisal; in the case of oil and gas reserves, this requires a property evaluation by the bank's oil department or an outside consultant. Capital requirements for drilling and service companies are usually for new or additional equipment. This equipment, then, is the collateral available for financing. Banks traditionally loan on the order of 80% of the purchase price of the equipment. The term of the loan is usually three to seven years depending upon the physical life of the machinery, area of activity, and company/bank relationship.