The Shale Revolution: Expanding the Use of Alternative Financing Structures

THE BOOM: It is difficult, if not impossible, to survey the current energy landscape in the United States without seeing the phrase “shale boom”—for good or for bad—somewhere in the rhetoric. In the past 10 years, technological advances in fracking and horizontal drilling have drastically changed domestic production and overhauled the possibilities for the future. The U.S. shale boom is attributed with not only record U.S. gasoline exports and record increases in domestic crude production, but also lower gas prices for U.S. consumers, increased jobs for American workers, reductions in carbon emissions and even a possible boost to Black Friday spending in 2014. And in the realm of U.S. policy, the shale boom has provided a market response to concerns of foreign oil dependence that many would say is unrivaled by any formal government response. For these reasons, some say the “shale boom” is actually a “shale revolution” if we consider that shale advances have created a fundamental shift in the North American energy landscape in a relatively short period of time.

OPPORTUNITIES ABOUND: Despite a period of low crude oil prices and more organized opposition to fracking, the opportunities stemming from the shale revolution continue to be seen. For instance, U.S. infrastructure demand continues to expand resulting in new development projects cropping up around the country. Adequately servicing the capital needs for such projects has meant that new financing sources and alternative financing arrangements are being explored. For example, several years ago when record Bakken supply met with undeveloped infrastructure and therefore constrained delivery options, it created rapid demand in the rail car industry for new and converted rail cars. In turn, the demand for rail cars created increased demand for financing, which in turn encouraged new types of financing arrangements; the rail car space saw new entrants, including financial intermediaries, getting into the market.

HERE’S SOMETHING NEW: Outside of rail, the midstream space more generally has seen an uptick in interest from financial entities looking to employ alternative financing structures. “Inventory monetization” and other intermediation-type structures are being put into place either replacing in full, or working alongside on a much reduced level, traditional secured lending facilities. Key to a monetization structure is title transfer of the underlying commodity from the original owner (the “Client”) to the financing entity via a purchase and sale arrangement; such sale happens on a “true sale” basis and may involve commingled commodities. While the underlying commodity may eventually be sold back to the Client on an as-needed, just-in-time basis, such sale is not legislated by a pre-determined forward sale (different from a traditional repo-type structure). Often in a monetization structure the financing entity also is involved in supply and offtake/exchange arrangements connected to the Client.

THE GOOD AND THE GOOD: While many of the high-dollar, high-profile inventory monetization deals have been executed with refineries, such structures can be utilized outside of the refining space to assist, for instance, companies that hold title to commodities in storage or transit. A monetization structure is intended to positively (1) provide an initial injection of capital, (2) deliver off balance sheet treatment, (3) alleviate/decrease capital-intensive supply chain or offtake requirements, and (4) offer reduced capital costs. Monetization structures are interesting to financing entities because these structures are geared to be credit neutral and can be employed for a wide spectrum of credit profiles (including very credit-challenged entities). These alternative structures diversify the manner in which financing entities participate in the commodities space with a strong focus on the Client relationship. Financing entities are smart to take into account “true sale” considerations for these types of structures in order to mitigate against re-characterization risk in a liquidation scenario.

THINK CREATIVELY: As opportunities from the shale revolution continue to develop, and considering the possibility that such opportunities will require more capital input than may be easily available, it is advantageous to consider both traditional and alternative sources of financing to best optimize capital availability.