Considerations in Bank Financing of Producing Oil Properties

Abstract

Abstract The chartered banks in Canada play an important part in the oil and gasindustry by providing a large source of funds through oil and gas productionloans, and these loans permit a number of advantages to producers in borrowingagainst production. Production loans are self-liquidating in that repayment of the loan isobtained from the proceeds of the sale of production from the same propertythat provides security for the loan. The development of engineering reservoir techniques and the practice ofproration has permitted forecasts of production and income under relativelystable marketing conditions which provide a sound basis for the loan. Three principal elements considered in a production loan are: 1. The factors which determine whether the borrower can be described as a"good borrower." 2. The engineering report and economic and loan evaluation of theproperties. 3. The legal documentation and registration of security. A number of criteria are used by the banks in determining the amount of aloan which can be advanced against a given property. These criteria relate tothe projected net income, reserves, and fair market value of the property. When all of the requirements have been satisfied and the amount of the loanagreed upon, security is taken by a very simple document which is provided forby Section 82 of the Bank Act. Oil payment loans are widely used in the United States for oil propertyfinancing. Canadian tax laws differ from those in the United States and thesedifferences, particularly the absence of a provision for cost depletion, haveprevented the application of oil payment transactions in Canada. Although the chartered banks in Canada provide loans to all phases of theoil and gas industry, from exploration through marketing and distribution, thepurpose of this paper is to discuss only those loans which are made to theproducing segment of the industry against the security of oil and gas in theground and retired from the sale of production of the same oil and gas -the socalled production loans. It is intended to describe the criteria generally usedby the bank to determine the amount which it can safely lend against thesecurity of an oil or gas property, in order to provide a guide for theevaluation engineer. He should be able to make a reasonable estimate of theamount which can be borrowed so that he can advise his management properly ofthe economic and engineering feasibility of any project. This is especiallyimportant where a decision between alternative investments must be made and allof the economic factors must be considered.