Oil and gas producers in the United States are turning to the financial magic of Wall Street to fuel their acquisitions in a frenetic race for growth. To achieve this, they are packaging thousands of pots into investment vehicles and selling stakes to American investors, replicating the exact same model that has long been used for mortgages, auto loans and other sources of securitized income.
Away from the spotlight, the number of these operations has grown rapidly in recent years. Industry experts consulted by Financial Times estimate that the total amount of debt issued through this format already ranges between $20 billion and $30 billion. It is a fundamentally opaque market, where most transactions are closed privately.
Historically, independent oil and gas producers financed their operations through reserve-based loans (RBL) and high-yield debt. However, the situation has changed drastically. Some commercial banks have reduced their exposure to the extractive sector to meet their sustainability strategies under environmental, social, and governance (ESG) policies or in response to public concern over climate change.
This shift has led to fears among traditional investors about “stranded assets” and general uncertainty regarding the long-term viability of the sector amid the energy transition. Rising interest rates have further raised costs, making high-yield debt too expensive or inaccessible for many producers.
In response, companies have found an alternative way: transferring their mature wells, known as proven, developed, and producing (PDP) reserves, to newly created Special Purpose Entities (SPE). This structure operates independently and is designed to be “bankruptcy-remote,” ensuring that the transferred assets remain separate from the producing company’s balance sheet and secure in case of bankruptcy.
Attracting Conservative Money
By isolating these high-quality assets, the bonds issued by the SPE achieve an “investment grade” rating. This quality seal attracts a new class of investors—pension funds, insurance companies, and large asset managers—who are typically reluctant to engage with oil risk but seek structured financial products with stable returns.
For the oil companies, the business has been lucrative. The securitization allows them to obtain advance rates ranging from 55% to 75% of the reserves’ value, significantly higher than traditional RBL loans.
To secure favorable ratings from credit agencies, the strategy often involves grouping thousands of wells together; for example, Raisa Energy recently closed an operation combining over 3,000 wells operated by more than 50 companies across 20 counties. Additionally, long-term hedges protect investors from oil price fluctuations, covering up to 85% of the entity’s production for periods of five to seven years.
The “Time Bomb” and Cracks in Private Credit
However, this financial engineering can conceal structural weaknesses. Brandon Davis, founder of energy intelligence company AFE Leaks, explains in the FT that these price hedges act like a “ticking time bomb” if other production costs rise. If oil prices increase, the company’s income is capped because the surplus goes to the hedging counterparty, usually a bank. Coupled with rising operational costs, such as field services or water treatment, the profit margins supporting the bonds could erode significantly.
The issues observed here are symptomatic of broader struggles within the obscure realm of private credit on Wall Street, where investors are beginning to demand their money back. Notably, in Cliffwater’s $33 billion fund, clients requested a 14% capital withdrawal in a single quarter, yet the firm could only provide around 50% of those requests, leaving the remainder in limbo.
Should panic spread, traditional banks might also face dire consequences. Lending to non-depository financial institutions, including private credit, reached $1.2 trillion mid-last year, nearly tripling its share compared to a decade ago.
The Danger of Forgetting the Nature of the Business
Wall Street has managed to package a high-risk industry into a seemingly tame product, but geology and global market dynamics remain challenging to manage. “The trick has always been to convince the rating agencies that measures have been put in place to mitigate risk,” warns Olivier Darmouni, a credit market economist at HEC Paris. “But the volatility inherent in oil and gas remains.”
Darmouni emphasizes a crucial risk: “If something goes wrong, the biggest issue may be that oil and gas will run out of capital” as producers start defaulting on bond payments.
As long as capital keeps flowing, the system appears stable. However, as Laura Parrott, head of private fixed income at Nuveen, cautions, the market is experiencing considerable effervescence. In such investment-happy scenarios, she notes, “people are going to be trapped.”
Image | Photo by David Vives on Unsplash
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