New realities (market players, behaviors, obligations, etc.) can be introduced through legislation. However, national legislation must take into account the pre-existing realities: geological specificity, infrastructure, consumption values, etc., as well as the existing supranational regulations and agreements. One of these realities that is placed outside the sphere of influence of the domestic legislation and regulations is the how operate the big financing institutions, without which far-reaching projects cannot be imagined, nevertheless started. In the context of the extensive review of the legal, fiscal and regulatory framework in progress in Romania, the presentation Oana Mogoi, Head of Energy Sector at ING Bank Romania had at 2018 Energy Strategy Summit on the subject of reserve based lending comes with useful insights.

I thank the organizers for the initiative and for the invitation, and also to my colleagues in the panel whom I feel honored to join today. If anyone in the room wonders why a bank is present alongside some of the most important industry specialists, I will now give an explanation. First of all, it is about the potential of this sector and its contribution to energy security and the development of the Romanian economy. Secondly, it is about the financing sources needed for investments, the bank financing being obviously one of them. Thirdly, ING has an increased interest in the energy sector sustained by a strategy in this respect. We have a sectorial approach; we have segmented our activity on the major industries we consider to be important in developing the economy of a country. We have the same structure in all the regions where we are present, and this means a unitary approach, as well as a good specialization. Specifically, we know at any time who deals with the energy sector and its sub-sectors in any country where ING is present, whether we are talking about the American continent, Europe, Middle East, Asia or South-East Asia.

Practically, we can collaborate with our colleagues from all of these areas to make sure we offer our customers a unique experience that translates into best practices tested and successfully applied around the world.

There are two reasons why I chose to talk about the oil and gas sector, namely financing of the Upstream operations, through reserve based lending; they are relatively new even globally – the first being completed in the ’70s – but are used on a much wider scale than in Romania. The first is related to Romania’s potential as a country, through the resources it holds, as evidenced by the latest onshore and offshore discoveries. The second aspect is related to ING’s experience in financing the Upstream sector, locally and especially at international level. In Romania, a single reserve based lending transaction was concluded and ING was one of the participating banks. We are also interested in other such transactions, because we know how to deal with them, we have a strategy as a group in this respect and we can always rely on the expertise of our ING colleagues from all over the world.

I will detail how we approach such projects and the essential elements we take into account.

Quality of the Investor

First of all, we look at the investor as behind every company there are people who run things better or on the contrary. Very important is their proven experience in the field, and the questions that we ask are: how many projects was the investor involved in?, what was their success rate?, is the activity of exploitation one of the main objects of activity? is the investor open and transparent?, has the investor confidence in his business?, has the investor the financial and technical ability to bring the project to a bankable phase?

Legal analysis

As we know, this type of projects need large land areas, whether we are talking about the exploration-exploitation part, infrastructure or connection to transport or distribution grids. Consequently, we need to make sure, from the very beginning, that the ownership rights were dully obtained, so we can fix all problems, if any. We need to verify the permits and authorizations, for the whole life cycle of a field, from the exploration phase to the construction and commercial exploitation. We also need to look at the concession agreement; in general, this legal analysis is outsourced to an external law house. Here, indeed, we are talking about a rather difficult procedure, as information related to oil & gas resources is confidential by law, therefore access to it has to follow a formal procedure.

The quality of all parties involved in the project

We then look at all the parties involved in the project, from the equipment and technology suppliers to the constructors, whether they are those who do the drilling, or those who are building the infrastructure. It is very important who these suppliers are, what experience they have, what their financial capacity is in relation to the obligations they have assumed in the respective contracts, whether there are fixed delivery terms, fixed prices and what guarantees are offered if these are not fulfilled. Another aspect that we take into account, and which is subject of a technical due diligence, is the technology itself, the drilling technique, the drilling depth, and of course the reserve analysis that I will detail later on.

Business plan

The most important aspect is related to the business plan analysis, from income and expensed to cash-flow assessment, with the aim to calculate a stable and predictable cash flow that is sufficient not only for loan repayment, but also for all the obligations assumed in the concession agreement, in the development plans submitted to ANRE, as well as for all the taxes that this sector implies, because without these projects cannot continue.

As about the revenues, there are two components: production volume and oil & gas prices. Production is based on the reserve analysis, which is usually confirmed by a third party; it must be approved and submitted to ANRM and it is updated annually. The purpose of this exercise is for us to identify future production with certain probabilities. We are talking about those 1p, 2p, 3p – meaning 90% 50%, 20% probability of production – that give us an indication about the risks associated with the exploitation of reserves. Banks generally look at the 1p indicator, the proven reserves; they may already be developed or undeveloped. Developed means that the wells are already in operation, and in this situation, it is very important to know since when the production started and where is placed on the depletion curve. If they are undeveloped, we obviously need to know what the future CAPEX is and we also need to address the well development risk, because we know that not all drillings brings up to the surface the results we want.

In terms of forecasted income, the price is very important. As explained earlier by the other speakers, indeed, banks require long-term, preferably fixed-price contracts, concluded before the loan is made available. Counterparty risk is also very important, because if we have a long-term contract with a company that after two years, for example, is breaching its obligations, practically there will be no contract in place anymore.

Without such contracts, things get very complicated. We will have to look at prices and consumption evolution, what strategies does the country have in relation to these resources (to use them for house heating, to export them, is export possible, to what extent?). Such an analysis is complicated and in any case involves risks related to market developments, for which reason the common approach globally asks for the existence of such contracts as an important element of the financing.

As about the expenditures, apart from the standard operating costs, we have to make sure that all taxes – be they royalties, special taxes, or others – are paid, which brings into discussion the legislative risk.

The legislative risk is different from the other risks a project in the energy sector is subject to. And that is because for all the other risks, the market offers mitigating instruments, while in the case of legislative risk, practically neither the bank nor the investor has any real control. A volatile legislative framework involves more sensitivity scenarios applied to the business plan, thus a lower level of estimated cash flow, which has a direct impact on the size of a financing. The conclusion is that the investor feels a double impact because of the legislative risk; in addition to the risk itself, the second effect is a lower financing, which means practically a higher contribution from the investor or a slower development of the field. This influences the investor’s decision to direct his money to another sector that is less dependent on the regulatory area or perhaps better remunerated.

Then comes the operating cash flow calculation, which is discounted by a discount rate, usually the interest rate. The resulting value is compared to specific rates for such financing, namely LLCR (Loan life coverage ratio) and FLCR (field life coverage ratio), which have known benchmarks – 1.4-1.5, respectively, 1.7-1.8. As a result of this comparison, we reach a financing ratio of 65%, maximum 70% bank debt. There are also other things we look at, such as the reserve tail; we will always compare the loan outstanding with the remaining reserve, the general accepted buffer being 25%.

These are the elements that we analyze and base our decision on when sizing a loan. Generally, our interest in oil & gas sector implies the entire economic cycle, from Upstream to Midstream – Transport, Distribution and Downstream and at a larger extent, to the entire energy sector.