A wave of restructuring will wash through the North Sea oil industry as firms battle to make themselves “fit” for the new reality, a top accountant has said.
But an outbreak of insolvencies is unlikely, at least in the immediate term, according to KPMG director Geoff Jacobs, a specialist in restructuring and insolvencies.
Jacobs said firms were using government loan and job retention schemes to “hibernate”, waiting out the initial icy blasts of the downcycle.
Many are currently engaged in short term “operational restructuring” aimed at adjusting “day-to-day” business processes.
This has led to redundancies at oil companies who predict the sector’s fundamental issues are still going to be there when the Covid-19 lockdown lifts.
They are trying to “right-size” their business, rather than “kicking the can down the road”, Jacobs said. More fundamental debt and business restructuring is waiting “further down the line”, however.
Jacobs said government loan schemes may have helped prevent a flood of insolvencies from occurring, but they will have some side effects.
Though the schemes are “soft and supportive”, they are loans, at the end of the day, and will increase firms’ debt burdens, Jacobs explained.
Companies will eventually and unavoidably have to consider how to deal with the debts they have been accruing.
Jacobs said: “As a result of the debt build-up, companies are going to have to agree to get debts written off, rescheduled and bring in new money, if they can, or look at other mechanisms such as a company voluntary arrangement to restructure the business. In two to three months, that is likely to come far higher up the agenda.
“If I summed it up, it’s more around operational restructuring at this stage – how do we adjust the day-to-day business processes? As the market picks up it’s going to be more around financial and balance sheet restructuring.”
Jacobs said the last downturn, starting in 2014, resulted in fewer insolvencies than might have been expected, but that a large number of debt and balance sheet restructurings took place.
So, in some ways, history could repeat itself this time around.
Jacobs said the last downturn was one of two recent “learning cycles” that will stand companies in good stead, the other being Brexit and the preparations that went with it.
Brexit provided a “great opportunity” for firms to get contingency plans in place around right-sizing, reforecasting and carrying out scenario planning.
Jacobs said: “I do think there is a lot of knowledge learned and because both of these major economic events happened in the relatively recent past there is a lot of experience and knowledge within the existing management teams that should stand companies in good stead to help.”
But, importantly, the supply chain is certainly more fragile than was the case in 2014. Worryingly, that hasn’t stopped customers employing the same harsh approach to price reductions this time around.
“What we are seeing harks back to 2014,” Jacobs said. “Letters are coming out to suppliers asking them to take price reductions of 30-50%, so the supply chain is under real pressure.
“As a result of being cut to the bone in the previous downturn, the supply chain does not have the same level of resilience as before.”
Is there anything service companies can do?
Jacobs says there is: “Suppliers are going to have to think more cleverly about how they deal with these requests to lower prices.
“Can we take a 30% price cut? Yes, but would the customer use three of our services, rather than one?
“How do we propose some upside while making cost reductions?
“Or, can we renegotiate payment terms?”
Encouragingly, clients do seem to be making payments on time, Jacobs said, before adding the caveat that a lot of the payments made in the last few weeks would already have been “in the system”.
“Whether payments will slow down is uncertain, but it seems they haven’t, so far,” he said.
There is at least one other “interesting dynamic” companies will have to consider – and it’s one not many people are speaking about, according to Jacobs.
Later this year, HM Revenue and Customs will regain its status as a preferential creditor in an insolvency, which means existing funders will be put in a far more exposed position.
Jacobs explained: “As of today, if a company was to go into administration and you’re a bank providing funding, you would have security in place.
“At the moment, HMRC does not rank ahead of the other funders, but legislation is going to change later this year.
“At that point HMRC will move further up the ranking and have preferential status, so lenders could see their position deteriorating as a result of that change and that could affect lender appetite for support.”