Resurgent Energy Sector Provides Opportunities and Challenges for Factors

In 2023, the energy sector continues to provide great opportunities for factors to demonstrate their flexibility and innovation when structuring facilities; however, it remains a cyclical industry which poses challenges to lenders and factors.

BY DAMON DICKENS, EXECUTIVE VICE PRESIDENT, SALLYPORT COMMERCIAL FINANCE

The energy sector enjoyed a strong 2022 and early half of 2023, as we have seen oil prices normalize from the peak in Q1/22 to a level of $75 a barrel in July 2023.

The ongoing effects from the conflict in Ukraine have now been absorbed into the energy markets and increased inflation has begun to move through the global economy. At the time of writing, inflation levels in the United States have dropped to around 3%, although in Europe and the UK, those inflation levels continue to be higher due to the impact of higher energy costs and food costs.

The energy sector is witnessing a steady shift toward increased renewable energy sources, and this trend is expected to increase in 2023 and beyond, driven by an increasing environmental consciousness, more mature renewable energy markets providing more efficient and better technologies, and government policy and incentives. The transition toward increased renewable energy does come with challenges in regards to energy storage and integration of renewable sources into the existing energy grid, so significant investment in infrastructure is needed.

Despite the push toward renewable energy, current energy usage still requires a significant portion of energy derived from fossil fuels and this is unlikely to change in the near future. The security of the energy supply has also become a hot topic recently and the renewed sense of urgency around security of supply has signaled a turning point for the oil and gas capital expenditure cycle.

Looking back on our review of the energy sector in 2022, several of the trends identified a year ago remain prevalent in 2023.

Outlook

According to Deloitte’s 2023 outlook for the oil and gas industry, the sector will continue to contend with several important trends, including more upstream opportunities fueled by strong balance sheets, increased government action paving the way for the clean energy transition, an increasing focus on natural gas and a slowdown in mergers and acquisition activity.

From Sallyport Commercial Finance’s perspective, banks are continuing to tighten on the credit side despite positive trends for the energy industry. With a somewhat uncertain environment for energy in an economy showing several indicators for a recession despite resiliency in the unemployment rate, banks are cautious about increasing their exposure to a cyclical sector like energy. Banks also have been less accommodating on increasing credit facilities or expanding working capital availability. Portfolio concentration limits on the oil and gas sector has meant some banks are declining new business or moving toward non-renewal of existing facilities.

The retrenchment of banks presents an opportunity for independent lenders — including factors — to provide a service to what could become an underserved area of the market in 2023 and 2024. Just from Sallyport’s vantage point, several oil and gas businesses have moved into the independent financing space recently, driven by such lenders’ ability to accommodate ongoing growth, lower covenant requirements and provide more flexibility in deal structuring, allowing businesses to utilize extra working capital in order to pursue profitable business opportunities.

Client Case Studies

Wind Power

Sallyport structured a facility for a UK wind power business which had recently opened a U.S. subsidiary. The business was a new startup and had a large concentration with an international debtor. The facility included credit insurance over the accounts receivable to maximize working capital to allow the business to grow and take advantage of the growing wind turbine repair market developing in the United States. As shown by this example, factors have a competitive advantage because they can finance new startup entities with no/minimal track record.

Oilfield Services

Sallyport recently closed a facility for an oilfield service company that was moving away from bank financing. The company’s bank was looking to reduce exposure to the oil and gas sector and asked the client to seek alternative financing. Sallyport worked with the parent company of the business on two prior transactions, so the business reached out for help structuring a bank exit.

Sallyport paid off the bank facility and generated a little extra working capital while demonstrating flexibility with the private equity group that owned the business. By demonstrating a track record of being supportive throughout the business cycle, factors can make businesses feel comfortable with their financing for the future.

Solar Energy      

One of Sallyport’s larger clients has grown significantly in the last three years. The business is an importer of solar panels from Asia and during its recent growth, it went through multiple facility limit increases while its revenue increased month to month. Eventually the business was to graduate to traditional bank financing, which Sallyport fully supported. Unfortunately, although the business had an offer in hand with a bank, there was some additional uncertainty around covenants and limitations, so the business ultimately decided to remain with Sallyport, independent financier, which required the payment of a little bit extra in fees. For this company, the additional costs were worth the additional flexibility, especially after having built an excellent relationship with Sallyport, particularly during the supply chain issues of 2021 and 2022.

For factors and independent lenders, your ability to remain flexible when clients are faced with challenges remains a key selling point. Our industry is not a ‘fair weather’ industry. As the old adage goes: It’s easy to give someone on umbrella when its sunny outside. When it’s raining, there are fewer people willing to step up.

Recruitment Firm

While not a direct business in the energy space, Sallyport has a client who is a temporary staffing company focused on the energy sector. It experienced record levels of monthly revenue in the second half of 2022 and the first half of 2023. After mass layoffs during 2020 and 2021, several oil and gas entities are using temporary labor in order to ramp back up, allowing for flexibility if there is an upcoming recession.

Challenges and Opportunities

The energy sector and its related industries continue to provide a solid hunting ground for independent lenders and factors. With bank credit tightening on an already cyclical industry, now is the ideal opportunity for factors to step in and, under the right circumstances, provide flexible working capital solutions for this sector. However, challenges of financing businesses in the energy sector remain, including:

• Contractual debt – Ensure you review all material master service agreements (MSAs) when these are present, as typical challenges for factors can include extended terms, pay-when-paid scenarios and/or the outright refusal to pay a third party or factoring company. We you see a ban on assignment or a refusal to pay a third party, you need to obtain a waiver from the customer under that MSA. Even if you have had a good success rate in obtaining the waiver, it is something to consider during the initial underwriting phase.

• ‘Thin’ credit files on customers – In some cases, companies may be privately held or with minimal public information available. This can result in lower-than-expected credit ratings from external credit rating agencies. To combat this issue, you should obtain financial statements from customers (usually via a non-disclosure agreement) to better ascertain creditworthiness. You can also consider the exposure to a lower rated customer as part of your broader debtor mix. As with all factoring deals, a well spread accounts receivable ledger can provide comfort to a factor. I would also advise reaching out to your network, as its likely that the business has been factored by another entity. Ask what another factor’s experience was like? We can help each other and help the industry by sharing our experiences.

• Sector-wide changes/ESG concerns – The energy market can be positively or negatively impacted by changing government policy, so it is important to stay up to date with the latest legislation, particularly with the 2024 election window opening and the possibility of a shift in policy depending on a Democrat or Republican president in the United States. The ongoing support and incentives for the renewable/green energy space could be removed or reduced, and this may have a knock-on effect on the viability of some businesses.