Daily Times

Crude oil prices have dropped precipitously over the past 18 months, and while there has been a recent uptick, the energy industry is struggling. Despite laying off workers, cutting capital budgets and refinancing debt, 45 US oil and gas companies have filed for bankruptcy since the beginning of 2015, with more expected to follow.

Despite the strategic importance of oil and gas production to the US economy and even its national security, however, the Obama administration has continued to push its climate-change agenda, leading to new rules, regulations and restrictions on fossil fuels. The net effect will be to raise companies’ operating costs and limit their financing options.

The Environmental Protection Agency proposed new rules in 2015 to curtail methane emissions from new oil and gas wells and is now readying additional restrictions on existing wells. Also last year, the Interior Department announced new disclosure requirements and operating procedures for hydraulic fracturing (“fracking”) on federal lands. Then came the State Department’s gratuitous rejection of the Keystone XL pipeline in November. In his recently released fiscal 2017 federal budget, President Obama proposed a confiscatory $10.25 per barrel tax on oil-when West Texas Intermediate (WTI) crude was trading at $30 per barrel.

Most damaging is the regulatory pressure being applied through the banking system, which has dampened the credit available for energy companies. Oil and gas development is capital-intensive and marked by a depleting resource base and a continuing need for external financing, particularly when commodity prices are low. Access to credit is the industry’s Achilles’ heel. Bank loans backed by the value of oil and gas reserves are the cheapest type of financing and the main source of liquidity for upstream drilling programs. The value of the loan collateral-and the company’s line of credit-is redetermined semiannually-typically every October and April-to reflect real-time commodity prices and current company and industry fundamentals. In other words, these asset-backed loans are effectively callable every six months, thus limiting a bank’s exposure to loan losses or defaults.

Nonetheless, since oil prices started to decline in mid-2014, the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. have all increased their regulatory scrutiny of banks in the energy-lending business. This is allegedly due to concerns over the adequacy of banks’ capital and the potential for losses spreading through the financial system.

However, by any measure, the risk to the banking system from energy loans appears manageable. In the 2015 Shared National Credit (SNC) review conducted by bank regulators, the amount of oil and gas commitments across the federally supervised banking system totaled $276.5 billion or only 7.1% of aggregate SNC loans. For perspective, this is much less than the $1.3 trillion of student loans currently outstanding, which have a delinquency rate of roughly 20%-25%. Apart from a handful of energy-focused regional banks, most US banks have less than 5% of their total loan portfolios concentrated in energy.

Furthermore, most bank loans to oil and gas companies are made to investment-grade companies with diversified operations and strong balance sheets. For smaller high-yield and private energy companies, bank loans are almost always secured by a first lien, which makes them much more likely to be repaid in the case of a default.

Despite the facts, all three federal agencies have been publicly warning banks about their exposure to the oil and gas industry, the press coverage of which has only served to increase the correlation between WTI futures and bank share prices. This will lead to further cuts in financing for many cash-starved energy companies, turning a challenging credit situation into a potential liquidity crisis. Current estimates are that banks will reduce most energy company credit lines by roughly 20%-40% this month, compared with an average reduction of 5%-10% last fall.

There will be losses on loans to energy companies, and banks will no doubt increase their loss provisions. But the effect will be mainly felt on bank earnings, not on liquidity or solvency, and the losses will not pose a risk of contagion to the rest of the financial system.

Since the 2008 financial crisis, US banks have slowly been converted into the equivalent of regulated utilities. So it is fair to ask whether the climate-change ideology of the Obama administration is driving the current aggressive approach of bank regulators toward energy loans and, in turn, if this will have a chilling effect on bank lending to the oil and gas industry going forward.

Many large US banks-including J.P. Morgan Chase, Bank of America, Citigroup and Wells Fargo -have recently announced that they will no longer finance coal mines or coal-fired power generation. Crude oil and natural gas production may not be far behind.