Diversified Gas and Oil PLC, which operates over 7,500 conventional natural gas and crude oil wells in Pennsylvania, West Virginia, and Ohio, recently obtained $200M of capital in its first asset-backed securitization (ABS). These securities have had their name tarnished recently due to their significant involvement in the financial crisis that shook the world economy in 2008.
Asset backed securities work through issuing a bond or note. The bond then uses a specific asset as collateral for investors, should the issuer of the bond fail to meet the stated payments. The particular ABS class that was a major contributor to the recession used home mortgages as collateral. When individuals began to default on their mortgages en masse, the value of these ABS’s rapidly declined. Due to the sheer volume of ABS’s and their significant value in the market at that point, the crash in price sparked the largest drop in value for the stock market since the Great Depression.
The novelty of the ABS offered by Diversified Gas and Oil is the collateral used to secure it. As opposed to utilizing loans, this bond extended oil and gas wells as collateral. Diversified formed a special-purpose vehicle that now owns a 22% stake in the company’s vast network of wells. This subsidiary then issued notes paying 5% interest, repayable in 10 years. The main Diversified entity continues to operate the wells, and retains majority ownership of the asset portfolio.
The natural gas industry faced new challenges in 2019 as the price per million BTUs decreased nearly 30% from the start of the year. This has led to difficulties in obtaining commercial loans from banks, along with a slowing of investor interest on the equity side. Conventional debt offerings have also become less popular.
This new security option, however, opens a previously unforeseen avenue for gas companies to gain financing, which is vital to fuel growth in this capital-intensive industry. According to Latham and Watkins, the law firm advising Diversified on the deal, the company entered into a series of hedging arrangements in order to minimize the effect of fluctuations in oil and gas prices. There is also a clause explicitly stating that investor’s interests in the assets would be excluded from any bankruptcy that Diversified could possibly be drawn into. These factors helped to raise the confidence of the rating agencies, and Fitch rated the offering BBB- (a stable outlook).
As gas prices have remained depressed through the start of 2020, the success of Diversified’s offering could lead other energy companies to follow suit. While the possible impact on the industry has yet to be quantified, this class of security is certainly a tool that could be used to drive growth in the sector.
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