Fast reading
- The loan helped finance operations in a large gas condensate field in the Danish sector of the North Sea, which is crucial to the European Union’s efforts to reduce reliance on imported fossil fuels.
- As a reserve-based lending transaction, the amount the group was able to borrow was based on the value of the underlying reserves and re-examined every six months.
- The pricing of the transaction was also linked to various ESG KPIs. This built-in ESG component gave the borrower an incentive to keep a check on its CO2
Russia’s invasion of Ukraine in February 2022 undermined long-held European assumptions about the security of its fossil fuel supply. It was commonly held that Europe and Russia were locked into a secure, symbiotic relationship: Europe needed gas and Russia did not have the infrastructure to sell its gas elsewhere. But that assumption was turned on its head.
Before the war, more than 40% of Europe’s imported natural gas came from Russia. Countries such as Austria and Latvia imported more than 80%1.
Figure 1: Russian gas exports to the EU have collapsed
The global energy crisis that followed the invasion reignited the debate about Europe’s dependence on imported fossil fuels – and heavy dependence on Russia – and the need for many countries to establish energy security.
The majority of Europe’s oil and gas reserves are in the North Sea under the control of Norway and the UK – both outside of the European Union. The bloc’s biggest producer is Italy; followed by Denmark, which relies on a large gas condensate field in the Danish sector of the North Sea.
The Danish offshore field is currently undergoing a major redevelopment that is expected to increase net production by 90% and unlock gross reserves in excess of 200 MMboe2. The redevelopment is expected to decrease operating expenditure significantly and lower emissions at the field by 30%.
Reserve-based lending
In May, Federated Hermes was part of a lending consortium, along with various global banks, which signed a loan facility worth more than US$1bn with a large European oil and gas group to expand its operations in the North Sea.
As a reserve-based lending transaction the amount the group was able to borrow was based on the value of the underlying reserves. A number of factors are re-examined every six months: including the level and type of reserves (proven or unproven); the expected price of oil and gas; and assumptions about the borrower’s operating costs.
After drilling, the oil and gas was sold to off-takers – intermediaries which have long-term export contracts with the borrower – and upon delivery payment was made into a US dollar-denominated offshore account. The distributions from this pledged offshore account were controlled by the consortium of lenders and followed a strict ‘cash waterfall’. The self-liquidating offshore structure of the loan sought to ensure that Federated Hermes and other lenders were repaid as soon as possible – after money was set aside for any mandatory operating and capital expenditures.
Robust covenants
The loan had robust financial covenants and was secured on the underlying assets. The borrower pledged all of the security documents to the lending consortium – including the offtake contracts, project documents and operation agreements – so if anything went awry, the lending group had the right to step in and raise a claim against those titles.
As part of the deal, the lending group also employed engineers that visit the drilling site and review operations, check reserves and assess the technical workings of the facility.
In reserve-based lending, the semi-annual redetermination process is an important covenant. On top of standard checks – such as looking at the borrower’s net leverage – a group liquidity test is also undertaken to assess whether the borrower’s future sources of income meet its proposed expenditure plan over a projected period. Lenders also benefit from regular technical reporting on the operations by a third party.
The pricing of the transaction was also linked to various ESG KPIs
The pricing of the transaction was also linked to various ESG KPIs, which were dependent on whether the borrower met certain targets. This built-in ESG component gave the borrower an incentive to keep a check on its CO2 emissions.
The transaction yielded an attractive return for investors, trading at approximately 250-300bps above the bonds of similarly-rated independent exploration and production (E&P) companies3.
At the conclusion of the transaction, the gas was sold to one of the largest energy companies in the Nordics and piped to various facilities and onshore power stations in Denmark and the Netherlands and used to generate electricity. Once the redevelopment of the Danish offshore field is completed, it should extend the field’s life by 25 years and produce enough gas per day to power the equivalent of 1.5 million homes.4
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The value of investments and income from them may go down as well as up, and you may not get back the original amount invested.
1 Europe’s messy Russian gas divorce (brookings.edu)
2 Millions of barrels of oil equivalent (MMboe)
3 Past performance is not a reliable indicator of future performance.
4 Company Reports
BD014799
