[IliketoPuck]

Tron - I read through your posts last night, and thought I would try to explain how the E&P lending industry works a bit more clearly for you. It's an industry I worked in for several years in Calgary, so I know it quite well.

So, here goes!

Lending to the energy industry in Calgary can be broadly classified into two categories:

1. Borrowing base loans (secured)
2. Covenant based loans (either secured or unsecured)

A secured loan simply means that the bank lending the money has the right to enforce security (i.e. take ownership) of a borrower's assets if certain conditions related to the company's overall health deteriorate. An unsecured facility means that if the company goes bankrupt, the lender does not have an immediate ownership claim on the company's assets, although they will have a priority in the court process as a debt lender.

A borrowing base loan is how banks lend money to smaller producers (typically those below 40,000 boe/d). The loan is based on a risk adjusted view of the value of the company's reserves, production, hedge book, and future capital spending plans. The borrowing base loan is usually reviewed by the banks twice each year (in the fall and in the spring), and the commodity price deck that is used to value the company's reserves and production is updated frequently to reflect market prices, with another risk adjustment included. Broadly speaking, if oil is at $45/bbl, you might see a bank's price deck anywhere between $30/bbl and $40/bbl. The reserves are evaluated by a third party engineering company (GLJ / Sproule) and the bank's own internal petroleum engineers as well. These types of loans are extremely risk adjusted, and do not reflect a 1:1 market value for the company's reserves and production; something more like 0.5:1 or 0.6:1.

A covenant based loan is typically reserved for the larger producers. When a company gets to around 40,000 boe/d of production, they will typically shift to a covenant based loan that can be either secured or unsecured. Unsecured loans tend to be reserved for the largest companies in town (Suncor, Encana, CNRL, etc.). These are governed by typical balance sheet / income statement tests like Debt/EBITDA, Interest Coverage, Debt/Market Capitalization, etc.

In the case of Penn West, they used to have a unsecured covenant based loan facility (if I recall correctly), but as their production and company outlook deteriorated, I believe the banks amended the credit facility to provide for security to protect their downside.

In general, I understand why you don't trust banks after reading/watching the Big Short - I personally never trust a single thing that Goldman Sachs ever says. While there certainly continue to be aspects of banking in general that lend themselves to that type of behavior, I can tell you from personal experience that the lending culture at Canadian banks is far more conservative and tightly controlled than in the States.

Not to get too far off track, but Canadian banks are part of the BASEL III guidelines, which represent the strictest lending protocols globally. Last time I checked, the American banks hadn't even adopted BASEL I yet. Basically, the Canadian banking industry is the global boy scouts of lending institutions.

Certain companies will go bankrupt in town as a result of this downturn, I would say that lenders are culpable to a certain extent in giving the borrowers enough rope (loans) to hang themselves, but the companies also need to accept the majority of the responsibility for not managing their finances prudently.

Feel free to ask any questions and I will do my best to answer.