Question

describe for me how a commercial banker determines the borrowing base for an oil and gas producer

Answer 1

Different industries have different methods to determine the borrowing base.

In the case of the oil & gas producer, the borrowing base is determined by the estimated value of oil & gas that can be produced.

This further needs detailing as the company can have proved reserves, proved developed and producing reserves and probable reserves.

The commercial banks focus primarily on proved and producing reserves. The reason is that these reserves provide cash flow visibility to the company. The borrowing base is therefore estimated and backed by value of reserves and the possible cash flows based on current oil & gas prices.

It is important to note that if there is a significant change in oil & gas prices, the borrowing base can be redetermined higher or lower.

On the other hand, the proved undeveloped reserves is not considered as it is not a producing property and cash flow from proved undeveloped reserves might still be few years away.

Another important point to note is that an independent valuation agency provides the level of proved reserves. This is done so as to avoid any potential inflation in proved reserves and hence higher than allowable borrowing base.