A&D experts, producers and investors should keep an eye on the looming capital shortfall for E&Ps in the wake of the unconventional resource revolution, according to Wil VanLoh, co-founder, president and chief executive of Quantum Energy Partners, Houston. He kicked off Hart Energy's recent A&D Strategies & Opportunities conference with a review of ripple effects from the massive US shale plays' financial calls on E&Ps' balance sheets, a consideration of whether it is wiser to be bullish or bearish on oil prices, and speculation as to whether natural gas prices have found a floor.
VanLoh called the capital intensity required to create and sustain growth from the unconventional resource plays in North America a dilemma for E&Ps, which emerged from the chaotic years of the land grab and are now entering the demanding development phase with their coffers depleted and their leverage at new highs. He referred to a chart from Jefferies & Co. that pegs the amount of capital required to develop the 11 largest resource plays, not taking into account the Permian Basin, at a mighty $2.1 trillion. Add in the Permian, he said, and the cost rises to $2.75 trillion.
“If you compare that to the enterprise value of the publicly traded independents, which is only about $600 billion, you can quickly see the dilemma,” he said.
The requirement to develop the plays over the next several decades is north of three times the publics' total market capitalization. Even including the majors and integrateds—at $1.4 billion—there remains a “huge, huge gap” in the amount of capital that's been allocated historically and what will be needed, he said.
Where did the dollars go? As the supply of gas and now, oil, soared in the wake of the shale revolution, prices for gas fell. He noted the futures strip for gas has cratered by 70% from its highs in 2008. The vast amount of capital that was “destroyed” in the land-grab years—defined as 2007-2012—was spent without the benefit of production history.
“While the resource plays appear large from an areal extent, when you dig down into the numbers, typically only about 20% to 30% or less of the acreage is economic at today's prices,” he said. “In the Barnett shale, at today's prices of $3.70, if those wells were drilled today, only about 12% would be economic.” Most of the Barnett wells need $6 or more, he said.
VanLoh outlined the process of capital destruction by comparing companies' weighted average cost of capital to the return on invested capital. “In the beginning innings of the resource plays, companies generated a 12% to 15% return on invested capital,” he said. As they went through the learning curve and the land grab, the publics' return on invested capital dropped significantly. “Today the average public company is not even returning their weighted cost of capital,” he said.
The public markets are waking up to this. “Investing behind best-in-class operators has never been more important,” he said.
Quantum's examination of the varying commodity prices required by operators to achieve decent returns in counties throughout the US resource plays proves the point. In the Bakken shale's Mountrail County, for example, best-in-class operators can earn a 15% return at $68 oil; the average producer needs $95 oil; and the bottom-quartile producers need $150 oil. In the Barnett, the best in class in Johnson County need $4.30 gas; the average require $4.95; and the bottom quartile needs almost $6.
As the land grab intensified, the percent of proved reserves in deals as a percent of acquisition cost trended downward. In the late '90s and early 2000s, most deals had proved reserves making up about 85% to 90% of total value. In 2011, proved reserves only made up about 15% of total deal value. In 2012 the percentage rebounded to about 40%. VanLoh quoted Richardson Barr's Scott Richardson on this point, who has said that today's buyers are looking for deals that have “rate, repeatability, running room and return.”
Acreage prices have also come full circle. In the Marcellus they have swung from $4,000 to $14,000 and back to $4,000 per acre. Additionally there are more well results.
“Interestingly enough, when you think about it, the risk-return opportunity for investors in the space has gotten meaningfully better over the past five to six years,” Van-Loh said. “People who have been patient are being rewarded for that patience….There is now a much better understanding of EURs, IPs, and drilling costs and therefore economics, yet investors can get in for $4,000 per acre,” he said. “We can intelligently put capital to work in this industry today.”
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