Energy lenders optimistic about demand but braced for setbacks

Energy lenders are hopeful that the recovery in the oil and gas sector will translate into loan growth, but they’re keeping reserves at elevated levels in case the delta variant once again slows the economy.

With fuel consumption on the rise this summer alongside a stronger global economy and increasing travel, oil prices are up about 25% in 2021. Natural gas prices have risen even more — about 60% since the start of the year, according to CME Group — amid scorching summer heat and strong demand for the fuel to power air conditioners in some regions of the country.

That's in stark contrast in 2020, when governments around the world limited travel and commerce, choking off demand for oil and curbing businesses’ use of gas. The turnaround this year emboldened bankers to predict increased drilling this fall on top of a recent bump this summer.

“Clearly, the strengthening in commodity prices has helped the entire energy sector,” Scott McLean, president and chief operating officer of Zions Bancorp. in Salt Lake City, said on the $87 billion-asset company’s earnings call in July. “You see drilling increasing” already.

Energy companies’ “credit quality has obviously been improving as well,” McLean said, noting that as prices strengthen and production increases, energy borrowers’ profits rise and their ability to repay loans solidifies. “We're seeing that and should continue to see that.”

However, the delta variant is causing a new surge in coronavirus cases across the United States and parts of Asia and Europe, threatening the energy sector just as it regains momentum. Oil prices, for example, have dipped lower in recent days as a result.

The International Energy Agency recently forecast strong growth in oil demand this year and next, though it lowered its expectations after virus cases rose in July.

The IEA said it expects global consumption to rise by 5.3 million barrels per day this year over 2020 levels and average 96.2 million barrels per day. That was down a notch from the agency’s July estimate of 5.4 million barrels per day.

It predicts demand will rise another 3.2 million barrels per day in 2022.

The downgrade was due to the worsening progression of the pandemic, the IEA said. However, it does expect consumption to continue rising and production to increase in tandem. Recent activity in the United States supports this.

The total number of rigs exploring for oil and gas onshore in the United States climbed by nine units last week to 500, according to Baker Hughes Co. The latest total is more than double the 244 rigs active in the same week a year earlier.

“There is also solid demand recovery in North America, China and Europe” that is fueling the need for greater supplies and more drilling, said Raymond James analyst Pavel Molchanov.

Loan growth has yet to materialize, but McLean and other bankers expect it will in the second half of this year.

Oil and gas companies typically prepare annual budgets in the fall, and this process includes making capital expenditure plans for the year ahead, said Stacy Kymes, chief operating officer of the $47.2 billion-asset BOK Financial in Tulsa, Oklahoma. More companies are expected to ramp up investments in drilling, and as they do this, they will finance the work with a combination of cash and loans, Kymes said.

“We see a real possibility for energy loan growth” by late 2021, he said in an interview. “The drilling activity — and expectations for more of it — creates loan demand. Based on the pipelines we’re seeing, there is a big opportunity over the next 12 to 18 months.”

Of the eight banks that reported the highest volume of loans to the energy sector, only PNC Financial Services Group in Pittsburgh posted a linked-quarter increase in the second quarter, according to S&P Global data. Notably, the $554 billion-asset PNC reported growth only because of its acquisition of BBVA USA Bancshares.

However, barring a sustained resurgence in the pandemic that forces widespread economic shutdowns, bankers predict energy demand will prove strong through 2022, supporting oil and gas prices.

“I think we're going to continue to have opportunities” in energy, Peter Sefzik, an executive vice president at Comerica in Dallas, said during the $88 billion-asset company’s earnings call in July. “We're encouraged by that and feel like it's a space we're going to continue to be able to be successful at.”

Yet because of the lingering uncertainty created by virus variants, “underwriting is probably more conservative than it was in years past," Sefzik said.

Comerica and other energy lenders also are holding onto more loan-loss reserves in their oil and gas books relative to other areas, largely because of the pandemic.

With cases on the rise in the United States and globally, Cullen/Frost Bankers is holding reserves at elevated levels and still watching closely for any new or emerging impacts on energy demand, Chief Financial Officer Jerry Salinas said.

“The September/October time frame will be interesting given that you've got a lot of employers requiring or requesting employees to get back to work after Labor Day. You'll have the kids back in school,” Salinas said during the $46.7 billion-asset San Antonio company’s earnings call a few weeks ago.

Cullen/Frost would likely maintain extra reserves through this year as it assesses the virus’s impacts this fall, he said. “As far as any discussion about [whether] we would be releasing reserves, that will really be dependent on what we're seeing at the end of the third quarter and at the end of the fourth quarter. Right now, I think there was just too much uncertainty … to release reserves.”