Problem in the Oil Patch – Oil, Oil Everywhere

With the world awash in oil, the problems that it brings become ever more evident.  With prices dropping precipitously, profitability goes down with it.  With more product chasing smaller demand, it produces an ever increasing price spiral downward.  As companies and Countries continue to produce, as produce they must, they are caught in this trap.

Aside from brick and mortar or in this case, land and drilling equipment, the next largest asset on a company’s books are usually its’ accounts receivable (A/R).  As company’s results continue to deteriorate, the risk of the A/R itself correspondingly are drawn down into this abyss.

There is a cure.  Not a cure all, but an option that remains available to the wide spectrum of players in this universe.  Whether you are a seller or importer of crude or refined products or a service provider selling pipe or other services, the market segment that you service can be addressed by utilizing a product called credit insurance.

Credit Insurance is an insurance product that is grossly underutilized, but has been around in this country since 1897.  It insures A/R against losses due to insolvency and or delinquency:  Domestic and or Foreign A/Rs are eligible for insurance coverage.  Risk is measured and a rate determined.  It is not designed for a single debtor but that is possible if the debtor qualifies for special packaging. The policies CANNOT be used for financial guaranty s; there must be an element of trade in the underlying transaction.  Policies are traditionally written on an annual basis on a multi-debtor platform.

Credit insurance functions at two levels.  The first is the black print of the policy as stated above: provides risk Amelioration. The second level of the policy, the white print, functions as a collateral enhancement vehicle.  To the extent that a policy is put into place, the policy can be used with a company’s lender in order to get a more user friendly borrowing package. Examples:  Higher advance rate on discounted A/Rs, eligibility of Foreign A/R inclusive of sovereign risk and perhaps even a lowering of the cost of borrowed funds. That of course is a function of the company’s balance sheet and the strength of the CFO in making the case.

The cost of credit insurance is remarkably low as it is measured in basis points (B.P’s).  The cost is volume sensitive.  As volume goes up, rate comes down. There is also a qualitative component to the pricing.  Prior to the current oil crisis, the quality of the debtors was significantly stronger and the appetite of the underwriters was correspondingly greater.  Today, amid all the losses, and the continuing failures, the underwriters are more difficult to please; but not impossible.  The debtor mix and client experience will determine the appetite of the underwriter for the particular package.

One of the most important components of this is that the cost is completely tax deductible, so to the extent that the policyholder is a tax paying entity, the government shares a significant portion of the cost.

In addition to providing both the black and white features of the policy, the policy will also offer guidance to the policy holder in that the underwriter will by his approvals and or denials offer insight into the viability of the debtors submitted.  The policy will also offer growth in that the policy can allow the policyholder to ship more than they might have been willing to ship on their own.

At the end of the day, credit insurance is a financial services tool, that if used aggressively can both help a company grow safely while enhancing its’ relationship with its’ lenders.

I am not an economist but I have been offering credit insurance to my clients for 44 years across many commercial areas.  The information is applicable to most industries.  The packaging will vary with the industry and the carrier.