CHAPTER 1 OVERVIEW OF MINERAL FINANCING
| Jurisdiction | United States |
(Nov 1982)
OVERVIEW OF MINERAL FINANCING
Peat, Marwick, Mitchell & Co.
Dallas, Texas
INTRODUCTION
The present environment for mineral industry financing can be described simply: harsh. The current recession has affected the mineral industry drastically. There is less money available from outside the industry, less demand for products, and less internally generated financing.
Generally, the pricing environment is bad. Oil prices are lower than a year ago. Uncertainty exists as to possible future gas price decontrol. The recession has caused a decrease in the industrial demand of and the price for metallurgical coal and many other minerals. Electrical utilities are generating less energy and temporarily using less steam coal. Other minerals have suffered similarly from the recession.
The stock market has treated mineral company securities unkindly. Energy issues and oilwell servicing stocks reflect investor expectations that oil prices will not increase markedly in the near future. Prices of mining issues reflect the lack of demand for product. Despite the recent bull market, energy stock prices generally remain well below their 52-week highs of late 1981.
Commercial bankers examine loan requests from the mineral industry with a jaundiced eye. One can hardly blame them after observing the collapse of the Penn Square Bank in Oklahoma City and the ripple effect therefrom on major money center banks around the country.
The recent tax law changes in the Economic Recovery Tax Act of 1981 ("ERTA") had an unexpectedly adverse effect on oil and gas exploration and development funds raising money through limited partnerships from individuals. ERTA has caused individuals to perceive oil and gas drilling as less attractive by lowering the maximum individual income tax rate and by enacting rapid depreciation deductions under the Accelerated Cost Recovery System that make alternative investments, such as real estate, relatively more attractive.
In short, the mineral industry has probably never been faced with a more challenging environment in which to arrange financing. Indeed, creative financing may be the key to near-term survival for many oil and gas and mining companies. With that harsh reality in mind, the Rocky Mountain Mineral Law Foundation designed this Special Institute on Mineral Financing.
The program of the Institute deals with creative financing of various mineral projects. The program was designed to review, in depth, most of the aspects of both debt and equity financing, including several of the less well known financing techniques which are receiving increasing acceptance under the present economic conditions affecting the industry. More specifically, the program focuses on such topics as bank and institutional financing in the
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mineral industry; legal documentations used in debt financing; representations and warranties, covenants and legal opinions in oil and gas mineral transactions; equity financing; practical securities considerations in public and private offerings; disclosure requirements and application of Federal securities laws to mineral financing; a review of government funding available for mineral projects; and other financing devices available to the mineral industry.
The Institute is aimed at attorneys, corporate financial officers, investment bankers, underwriters, and accountants engaged in financing energy and mineral projects. Obviously, the participants in the program have varied backgrounds. Some participants may be broad generalists, while others are specialists in limited aspects of financing. Recognizing the diverse background of the participants, we have designed this first presentation as a basic introductory overview to familiarize the participants with the organization of the Institute and the interrelationship of its topics. It is intended to provide the participant with a basic understanding of the oil and gas and mineral industries and their financing needs. Hopefully, it will give the participants some understanding of those areas of mineral financing outside of his or her area of expertise and allow him or her to relate the following detailed presentations to mineral financing in general and to the other topics.
Of course, a speaker's presentation is necessarily colored by his experience. Over my career, I have been involved with a wide variety of energy and natural resources transactions and industries, ranging from alcohol production to gob pile mining, from geothermal well drilling to gold mining. However, I primarily practice in the area of oil and gas exploration and production taxation. Accordingly, my comments will lean somewhat toward that area.
As previously mentioned, the paper will be an overview. Due to the broad scope of this paper, it will necessarily deal in generalities and will not try to address the subtle exceptions to the conclusions drawn herein. During the next two days, the other speakers will give detailed, technical presentations.
The general format of the paper will be a discussion of the life cycle of oil and gas and mineral companies and projects and the different financing needs during those life cycles. It will discuss the various techniques that can be employed to meet those needs. It will compare and contrast the oil industry and the mining industry financing needs.
First, we will review the characteristics and financing needs of the mineral industry today. Next, we will turn to a brief analysis of the more important Federal income tax provisions and accounting considerations affecting mineral financing. The presentation will then focus on the life cycle of oil and gas and mineral companies and projects, briefly reviewing the various financing techniques employed at each stage of a company's or a project's life. Then, we will turn to a brief discussion of some other financing techniques and topics. Finally, we will review some factors to consider in choosing the most appropriate financing techniques.
For the purpose of this paper, we will divide the mineral industry into two parts: the oil and gas industry, which will simply be referred to as the oil industry, and the solid minerals and coal industry, which will be referred
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to as the mining industry. While these two industries have numerous characteristics in common, they are quite dissimilar in many ways.
OVERVIEW
The Oil Industry
The oil industry is a composite of many functions, ranging from the search for the mineral in its natural, underground reservoir to the marketing of refined products. The mineral must be found in the ground, lifted from its natural reservoir to the surface, and transported to refineries, where it is manufactured into more than a 1,000 different products. Then, the products must be transported to markets and sold to consumers. In this paper, attention is given only to the so-called exploration and production phase of the oil and gas industry. This phase can be divided into three stages: exploration; development; and operations.
The goal of oil and gas exploration is to locate various geological traps for oil and gas which, in most instances, are found many thousands of feet below the surface. Generally, the exploration phase begins with the employment of geological and geophysical studies. The most important method of study involves use of the seismograph, which was originally devised to measure earthquake intensity. In this method of searching for oil, a shock wave is sent down into the earth by either a dynamite blast or physical impact of an object with the earth. Such waves are reflected by geological formations and recorded by sensitive detectors on the surface. Different types of formations are indicated by differences in velocity of the reflected shock waves.
Seismographic studies and other geological and geophysical exploration methods have become quite sophisicated in recent years. However, the only way to actually prove the presence of oil and gas is by exploratory drilling.
Once exploratory drilling indicates the existence of commercial quantities of oil or gas, the development phase begins. There is a significant overlap of the exploration and development phases since, usually, exploratory wells are used to produce oil and gas. In addition, depending on the size and character of the geological structure containing the oil or gas, a number of development wells may be drilled to efficiently extract the oil or gas.
In offshore oil and gas operations, exploration and development are more distinct. Quite often, a number of exploratory wells are drilled by mobile drilling ships to delineate the size of the reservoir and the extent of the reserves. Once reserves in commercially producible quantities are located, a drilling platform is moved onto the site. From that platform, a number of developmental wells are drilled. In some cases, the previously drilled exploration wells may be re-entered.
Once exploration equipment is installed, the production phase begins. Oil produced from a well is normally stored in tanks either on the lease or in the field, awaiting delivery to a pipeline for transmission to refineries. Gas produced from a well is ordinarily delivered directly to transmission companies' pipelines.
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Generally, oil production is characterized as primary, secondary or tertiary. Primary production occurs from natural reservoir pressure due to driving forces such as natural gas or water and from the use of surface or subsurface pumps. Secondary production occurs from the stimulus of injected water or of natural gas. Tertiary production recovers oil left in place after secondary recovery methods are exhausted. Tertiary methods include rather exotic reservoir stimuli such as the injection of a combination of light liquids, injection of caustic chemicals, injection of carbon dioxide, and underground burning.
The Mining...
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