Rob­bing Peter to Pay Paul

Can get­ting in­surance on in­voices stop the cas­cade of non-pay­ment and bank­rupt­cies?

Alberta Oil - - CONTENTS -

Can in­surance on un­paid in­voices stop the cas­cade of oil patch bank­rupt­cies?


this pro­longed en­ergy slump. Yet some banks and savvy sup­pli­ers will ex­tend their lines of credit if they are cov­ered by the rel­a­tively un­known in­surance that cov­ers ac­counts re­ceiv­ables, also known as trade credit in­surance (TCI).

The ser­vice in­dus­try has been hit hard by the cas­cade of non-pay­ment, which Gra­ham MacLach­lan, man­ag­ing part­ner at Cal­gary-based bro­ker­age Global Trade Credit calls the “domino ef­fect.”

Mark Salkeld, CEO of the Pe­tro­leum Ser­vices As­so­ci­a­tion of Canada, says, “Some pro­duc­ers pay 180 days late—it’s ridicu­lous. No one gives that line of credit, not banks, not credit card com­pa­nies… If the money were paid in 45 days it would save the ser­vice firms money and let them help save the pro­duc­ers money too. We have mem­bers car­ry­ing pro­duc­ers for up to $50 mil­lion for 180 days.” He says, “Let’s just start pay­ing the bills and we won’t need this other stuff.”

Nonethe­less, Salkeld says “ac­counts re­ceiv­able in­surance is an al­ter­na­tive with­out a doubt.” If they do need the time, at least there’s some­thing to bridge the gap. Fac­tor­ing is an op­tion where some lenders will po­si­tion them­selves be­tween the pro­ducer and the ser­vice provider. “For ex­am­ple, a pro­ducer needs ser­vices to com­plete a well but the ser­vice com­pany needs op­er­at­ing cap­i­tal to get go­ing. So the lender pro­vides op­er­at­ing cap­i­tal, col­lects from the pro­ducer di­rectly, takes its cut and gives the bal­ance to the ser­vice provider,” Salkeld says.

Fac­tor­ing, how­ever, com­petes against banks by get­ting cash up front, so banks pre­fer com­pa­nies to use TCI to pro­tect their cash flow. “Oil and gas folks use let­ters of credit and some layer in­surance on top of that—oth­ers are so big they pro­vi­sion for bad debt,” MacLach­lan says. “Yet the cost of TCI is usu­ally less that 0.5 per­cent of the sum in­sured—it de­pends on the buy­ers and the coun­tries they are in.”

TCI also pro­vides other ben­e­fits. “If com­pa­nies are com­pet­ing to sell the same ser­vice or prod­uct to an oil pro­ducer, by us­ing TCI one can win the deal—it can of­fer longer credit term,” he says. Fur­ther­more, TCI al­lows firms to mar­gin in­ven­tory up to 75 per­cent from the usual 50 per­cent. If a com­pany has a $10 mil­lion line of credit maxed out and gets a big or­der it can’t refuse, if it takes out TCI, margin­ing against line of credit could get up to 90 per­cent of the orig­i­nal line of credit added to it, MacLach­lan says.

U.K.-based HSBC is ac­tively tar­get­ing the oil and gas sec­tor with its ac­counts re­ceiv­able fi­nanc­ing so­lu­tions struc­tured with TCI. It is un­usual in Canada in that it rec­og­nizes the nine top-tier in­surance firms that of­fer TCI here, while not all banks rec­og­nize TCI yet.

“To­day, we have a hand­ful of very strong com­pa­nies in most in­dus­try seg­ments, and qual­ity re­duces from there with a lot of con­sol­i­da­tion oc­cur­ring,” says An­drew Skin­ner, HSBC’s head of global trade and re­ceiv­ables. “What we tend to see is ac­cess to large credit fa­cil­i­ties is more se­lec­tive in the en­ergy sec­tor or as­so­ci­ated terms have tight­ened.

His­tor­i­cally com­pa­nies could ac­cess 75 cents against each dol­lar in re­ceiv­ables with most fi­nan­cial in­sti­tu­tions in Canada. To­day, with TCI they may be able to ac­cess 90 per­cent or more and in­clude in­ter­na­tional—not just do­mes­tic—sales if they choose the right part­ner.”

Fur­ther­more, com­pa­nies can ac­tu­ally sell their re­ceiv­ables and take them off the bal­ance sheet, sub­ject to their au­di­tor’s opin­ion of the pur­chase re­course terms. “This in many cases ma­te­ri­ally im­proves key work­ing cap­i­tal ra­tios,” Skin­ner says. TCI can also boost the stock price of pub­licly traded com­pa­nies as an­a­lysts view it fa­vor­ably.

A let­ter of credit from a bank is a standby se­cu­rity in­stru­ment, usu­ally good for a year, used when a com­pany might not have a healthy bal­ance sheet or its pri­vate bal­ance sheet is not dis­closed. This TCI pol­icy can be com­pleted with­out the knowl­edge of these com­pa­nies or other com­peti­tors. The let­ter of credit is also in­de­pen­dent of the bal­ance sheet and en­sures pay­ment in the event of bank­ruptcy. InRisk So­lu­tions is a Cal­gary-based credit con­sul­tant in the oil and gas sec­tor. Pres­i­dent Ian Ly­di­att says, “Some­times com­pa­nies who are your debtors can’t get one. You can then take out TCI to cover against their de­fault—a non-can­cellable TCI pol­icy is like a let­ter of credit.”

TCI can ben­e­fit firms other than ser­vice com­pa­nies. Ly­di­att gained his first ex­pe­ri­ence with TCI cov­er­ing En­ergy Exchange, the world’s first elec­tronic nat­u­ral gas trad­ing plat­form, a North Amer­i­can exchange that com­peted against


Canada’s Nat­u­ral Gas Exchange. En­ergy Exchange es­tab­lished credit lim­its for $2.5 bil­lion—the sum of 150 com­pa­nies’ credit lines. Un­der the later name of AlTrade Trans­ac­tions, it gen­er­ated US$16 bil­lion in rev­enues, 99 per­cent of which was cov­ered by TCI. “Any pro­duc­tion sold through the trad­ing sys­tem to a third party pur­chaser had to have its cred­it­wor­thi­ness ab­so­lutely con­firmed as it was in­te­gral to the trad­ing sys­tem that there were no losses,” he says.

TCI won’t end the cri­sis of en­ergy busts, but it may de­fer some for an­other 12 months—when hope­fully the next boom will be on the hori­zon.

“Oil and gas folks use let­ters of credit and some layer in­surance on top of that–oth­ers are so big they pro­vi­sion for bad debt. Yet the cost of TCI is usu­ally less then 0.5 per­cent of the sum in­sured [...] If com­pa­nies are com­pet­ing to sell the same ser­vice or prod­uct to an oil pro­ducer, by us­ing TCI one can win the deal—it can of­fer longer credit term.”

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