It's good to be a resource play in the U.S. M&A space this year. The first half of 2006 has been witness to the major players grappling for every last bit of the Barnett Shale, even going so far as to lease acreage beneath the Dallas/Fort Worth airport, despite the certain regulatory-approval frustrations developing this land may entail.

If the resource plays have become the belles of the ball, the Gulf of Mexico shelf has found itself a lonely has-been, watching many of its biggest players exit, thanks to declining reserve potential and uncertainty of repeatable results.

"The analysts are saying, 'The Gulf is bad, the Barnett is good,'" says Bill Marko, managing director with asset-marketer Randall & Dewey, a division of Jefferies. "There have been quite a few Gulf of Mexico shelf sales this year. The Gulf of Mexico has really fallen out of favor."

Among those exiting the shelf so far this year have been Kerr-McGee Corp., which sold its shelf properties to W&T Offshore and itself to Anadarko Petroleum Corp. during this half; Houston Exploration Co., which found a willing buyer in Merit Energy Co.; Noble Energy Corp., which sold to First Reserve-backed Coldren Resources LP; BP, which sold Gulf assets to Apache; and Pogo Producing Co., which sold half-interest in its Gulf assets to Japanese conglomerate Mitsui.

"Large public independents, with a handful of exceptions, have left the Gulf of Mexico shelf," says Mark Carmain of investment-banking firm Petrie Parkman & Co. "We refer to it as the treadmill because the wells deplete very rapidly; they only last for about two to three years. So every two to three years you have to re-invest your entire capital base.

"Contrast that to a pipeline company that has to replace its pipeline every 50 years. Every time you turn your capital base over, you subject it to finding and development risk."

How are buyers for these properties being found? "It's two-fold," says Sylvia Barnes of Petrie Parkman. "International companies are showing real interest. We've seen the Norwegians and the Chinese buy some of the asset packages. We're also seeing some private capital and private equity being attracted to the shelf."

For every company running from the Gulf shelf, two may be running to the resource plays, especially the Barnett Shale. And they're not just paying for proved reserves.

"You think that, when gas prices go down, unit metrics will go down, but what we're seeing is buyers are willing to pay up for resource plays," says Carmain. "That's a major theme we saw over the last two years in both the corporate M&A market and the asset market. We're seeing relatively small acreage positions and companies with limited acreage positions selling for very high cash flow multiples and very high multiples of proved reserves because they have a substantial inventory of drilling locations beyond what are booked as proved."

Part of companies' willingness to pay up for unproved reserves is the liquidity of the marketplace right now; part seems to be a need to get into resource plays, even if those assets haven't proven themselves worthy of their high price.

"I think a large part of it is simply more dollars chasing not enough deals," says Scott Johnson, co-founder of capital advisory firm Weisser Johnson & Co.

"Secondly, in the resource plays, there is a willingness to pay for drilling locations, both proved undeveloped and also probable and even possible locations to some degree, because there is a relative confidence they will prove out to be good wells based on extensive drilling that has already occurred in the play."

The most striking example of this trend in the first half of the year was the sale of privately held, Barnett-focused Chief Oil & Gas, which was handled by Petrie Parkman. Barnes and Carmain say the challenge in selling Chief was getting the right price for the properties, which only included some 350 wells. In marketing Chief, Barnes used the phrase "a rapidly emerging play with substantial nonproved value."

Carmain says, "The biggest challenge in selling Chief was convincing the market that the vast majority of Chief's position, which was 168,000 acres or so, was fully prospective for gas. Chief had basically financed the growth of the company through internal cash flows and borrowings. They were focused on building a good lease position, not drilling wells to maximize the number of proved undeveloped locations they could book.

"So you had a big acreage position with a fair number of wells. We mapped out about 1,800 drilling locations on Chief's acreage. Those are 2- to 4-billion-cubic-foot-of-gas opportunities per location."

Devon Energy Corp. paid a hefty $2.2 billion for Chief's upstream assets, gaining proved reserves of 617 billion cubic feet equivalent in the play and solidifying its position as the largest producer in the Barnett Shale with some 721,000 net acres.



The Anadarko deals

Acquisitions that shocked the marketplace in the first half of 2006 were two Anadarko Petroleum Corp. announced: the purchases of Kerr-McGee Corp. and Western Gas Resources for a combined price of $23.3 billion in cash.

"There is tremendous depth to the capital markets right now," Barnes says. "I find it really noteworthy that Anadarko was readily able to access capital to consummate these two large transactions."

To help pay the bill, Anadarko plans to sell some $10 billion worth of assets. Some sales had been announced a press time.

Carmain says, "Their ability to de-lever is also dependant on the liquidity of the sector. The buyers have to be able to pay for the assets Anadarko plans to put on the market. There is a tremendous amount of capital in the sector right now. The overall liquidity of the sector has fueled a lot of M&A activity and it will continue to do so."

A large source of capital in the M&A space is coming from private equity. (For more on capital access, see "The Capital Push" in this issue.)

Marko says, "There is so much private capital wanting to get in the market. It's smart money being given to smart people trying to figure out how to do smart deals. Everybody has a billion-dollar fund they are trying to place. We're seeing unbelievably big numbers in the space right now. Some of the increase is because barrels cost more these days, but most of it is just increased deal flow."

Johnson says, "The key is sticking to good old hard work to make sure that, despite the frenzy, you understand the properties and pay an amount that makes sense and where you're going to make money in the long run."

Adrian Goodisman, managing director for investment banker Scotia Waterous in Houston says, "A surprise to me has been that, even though gas prices have come down compared with last year, the higher metrics are still being paid for gas transactions. The strip is still bullish when you get out long-term. The outlook and the forward curve are both still aggressive."

Rob Bilger, managing director of acquisitions and divestitures for investment banker Tristone Capital in Houston, says, "Everyone would like to buy at the bottom of the commodity-price cycle and sell at the top, but you can't predict what's going to happen with the weather or with Middle East stability. The successful buyers assume the forward-price curve in their economics and either hedge or are comfortable with the risk."

As long as companies continue to have confidence in the market, expect the second half of 2006 to be just as busy in the U.S. M&A space.

"Major asset transactions in the first half were a little more active than in 2005," says Bilger. "The marketplace will continue to stay active as long as there are no wild price swings. It's hard to get deals done when people don't have confidence in prices. Relative stability, which we've had, is the key to a busy marketplace."

Tom Hedrick with asset marketer Wells Fargo Energy Advisors in Houston says, "Traditionally, people try to exit in the fourth quarter of any given year to capture any year-end pricing premium. That is not always the best strategy. Companies can do just as well when they sell in the first or second quarter.

"The current cycle is getting a bit long in the tooth. I'm not a very good prognosticator, but most people believe it's a great time to exit and want to capture premium deal metrics before a cycle-ending event happens, as it always does. No one realizes what that event was until after it has already occurred."