Like other E&Ps, Northern Oil and Gas Inc.’s fortunes have risen in the past 12 months with higher commodity prices, leading to an 85% increase in its stock price as of June 14.
Along the way, even in the depths of the pandemic, the company has continued to make deals that, if its most recent acquisition closes, will total more than $2 billion since 2018. Northern’s more recent step-outs into the Permian Basin and the Marcellus have expanded its nonop business model—and set up a strategic balancing act as the company continues to expand.
Most recently, Northern announced a $170 million bolt-on acquisition on June 7 in the Williston Basin. The deal with an undisclosed party is expected to close in August and features a $5 million contingency payment based on 2023 WTI prices.
“There are a ton of assets out there that we have looked at that we really wanted to own. But we just had materially different views on what they were worth with the seller.”—Nicholas O'Grady, CEO, Northern Oil and Gas Inc.
Despite the company’s rapidly increasing cash flows and its success in the A&D market, including 10 “ground game” deals balanced between the Williston and Permian basins in first-quarter 2022, Northern CEO Nick O’Grady hasn’t clouded his mind with braggadocio. Rather, he says Northern’s transactional successes obscure “a lot of failure, honestly.”
“Our batting average is very low this year,” he said. “We’re like a duck on a pond. It looks nice and smooth, but we’re paddling furiously underneath all the time.”
O’Grady spoke exclusively with Hart Energy on June 13, where he discussed the tailwinds pushing deals in the Williston Basin, his company’s $900 million acquisition budget, and the possible peril of continued commodity price escalation and an economy that starts to fizzle. Editor’s note: Questions and answers have been edited for clarity and brevity.
Darren Barbee: What’s prompting to you to do deals in the Williston Basin and do you have a preference now that you have a position in the Permian?
Nick O’Grady: On the whole, there are fewer players remaining both at the operated level and the nonoperated. So, I think it’s a little bit less competitive in general because it’s down to the serious players. There are some tailwinds for the Williston. Everyone has a different view, but there are about 35 rigs working in the Williston today. There are hundreds in the Permian. And so, because there are only 35 rigs, they’re all active generally in highly consistent areas.
We see the best of the best in the Permian and we also see the worst of the worst. So, there’s a lot more variability within the Delaware Basin and even in the Midland for that matter.
Our data set is the strongest in the Williston. But in general, the bell curve is a little tighter in the Williston in terms of properties that are coming on the market. And then added to the fact [is] that there’s a little bit of a Goldilocks scenario going on in North Dakota where production’s relatively muted, activities relatively solid, but it’s not growing as fast. So, you haven’t had the same inflation pressures.
You’ve also seen very, very strong pricing where the midstream infrastructure, which kind of caught up finally in 2019 right in time for the pandemic to start. As a result, pricing in the Williston is really, really strong. So, I think the economics are really great.
DB: So, is the Permian simply less competitively priced to strike a deal?
NO: The Permian has materially more resiliency at low prices of about $55 or higher. The delta between those returns is relatively de minimis. It’s not that we’re not continuing to grow and add in the Permian. I think we’ve just had more, probably a little more success than even we expected in the Williston this year. I mean, it’s been closer to 50:50 weighting, even on the ground-level stuff.
Maybe it’s competition, maybe it’s just the variability and the economics. And just at the end of the day, these [Williston] assets in particular were with a group that we’re close with and that we’ve had an existing partnership with them in the past. They really built this asset in a very sort of surgical way, meaning that the concentration was in these super, highly productive. Some of the Dunn County oil cuts are the highest. The wells are in some of the most productive parts and concentrated on what we would view as you know I think 93% of the value is in three operators who are our top operators in our view.
DB: You’ve been one of the most consistently active acquirers since 2018 despite volatility, bid-ask spreads, and more recently the fluctuating market. How are you able to continue making deals in the backdrop of calamity?
NO: We looked at two other Williston packages almost identical in size and scope to this one and kind of happenstance the bidding was all due around the same time. I talked a little bit about this on our [May] first-quarter call, which is that generally, we found in M&A, there has to be a reason. So, it’s really just taking swings at-bat. When we did our first material Permian deal, last year, we got laughed out of the room by three other parties who said we were a 100% off.
At the end of the day, you need a counterparty that’s realistic that buys and sell with the same methodology. There are a ton of assets out there that we have looked at that we really wanted to own. But we just had materially different views on what they were worth with the seller.
“That’s one of the new things about being the nonop is that we don’t add any supply to the market. So, the market doesn’t seem to, you know, get really angry at us if we actually grow.”
We are failing probably more than we even did last year, but even last year was sort of a freak anomaly where we just happened to be in processes where there were specific reasons that the sellers wanted to sell.
DB: Northern President Adam Dirlam mentioned during your May earnings call this idea of dealing with realistic sellers. What did he mean by that?
NO: A lot of people test the market. A lot of people have a view that their children are more beautiful than everybody else’s. That can be really frustrating for us because, you know, we go through a ton of frontend work to evaluate these properties. And so, you want to deal with counterparties that are serious. But you never really know, honestly, until you try.
Oil and gas is a DCF business. So, at the end of the day, it’s how much money do you put in the ground, plus your cost of entry and then how much money do you get out? And what’s the implied IRR or effectively net present value of that money?
If we put, we spend $50 million to buy something and $100 million in cash flow in the ground, what's, what's the cumulative cash flow discounted back to today? That’s the only way to evaluate it and timing is always going to be different, and prices are going to be different. The whole concept is we want to earn our cost of capital and then some and earn a reasonable return.
Most of our counterparties are relatively sophisticated and they’re buying it with the idea that they want to earn a return. [But] we get a lot of people who say, “OK. I paid $100 million for this. And I think it’s going to cum. $200 million of cash over the next 10 years. And so, my price is $200.” And I was like, well, you’re not going to get all of that. I mean, what’s in it for us, right?
So, we find a lot of sellers don’t have the same rules for how they bought their assets versus how they sell them. And so realistic people are people who understand our methodology because it’s the same as theirs when they put the thing together.
We’re okay to lose. We don’t really need to do anything. We’re only doing it if can make us better.
DB: On June 7, Northern said its borrowing base had been increased to $1.3 billion from $850 million. Are you still planning a $900 million acquisition strategy this year?
NO: One nuance I’d add is we’re a large enough company that we can bond out any borrowings we want to make. So, it’s not even the RBL, but the unsecured debt market is open to us at relatively reasonable rates. I mean, our bonds are still well above par, even as rates have gone up several hundred basis points.
But there is a feature in our RBL. We only elected to take $850 million of the 1.3 billion, partly because we don’t need it. But we have a feature in there in which we can kind of create a side loan within the loan [to access] that untapped capacity.
DB: And your acquisitions budget? Where are you on that?
NO: I think it’ll be like a rolling target, but I would think of like $900 million as one year. And the likelihood that we get $900 million of deals done this year is relatively low. I mean, I guess never say never, but I would think that would be kind of how much we could do today in one year.
Maybe now that we’re scaling the business you get into next year, and that number moves up a little bit as you just get bigger. And 2023 is setting up to be a material step up, even from this year, just as we’re growing throughout the year. That’s one of the new things about being the nonop is that we don’t add any supply to the market. So, the market doesn’t seem to, you know, get really angry at us if we actually grow.
DB: On the ground game, your budget is $40 million. How is that playing out?
NO: This year’s turning out to be very similar to every year, which we always start every year and think it's going to be different. And it's the same, which is that oil prices rallied early in the year. We saw huge amounts of wellbore development programs being shopped by operators. And then they say, “I don’t want to spend this money because I’m dealing with inflation and I want to drill my own wells.” And we see this huge flurry of competition and people paying what we view to be very aggressive prices early in the year.
And we didn’t have a ton of success. You get to about the middle of the year. And actually, the numbers start getting bigger, meaning the projects that are being sold are larger. And we find ourselves suddenly competitive again. So, we didn’t have much success on the ground in the first four months of the year. Then in the last month we did about four [transactions]. We had one in April and about four in the month of May. And we realized that Adam Dirlam’s inbox was filling up with more [leads]. And we allocated some extra capital to this because we find that our competitors tend to spend a ton of money upfront.
DB: Has anything in particular changed as the year has gone on?
NO: The one thing we’ve noticed this year is we’re seeing really large interests, like meaning that it’s not 10% of a net well, or a fraction of a percent we’re talking about, you know, where an operator has a nonop stake and another operator as well. The interests are 40% and 50% working interests.
These are much bigger and concentrated things and the dollar numbers are a lot larger. We’re finding we’re making hay there.
DB: In which basins?
NO: It’s been about equal-weighted. Even though there’s probably 10 times the volume in the Permian, as there is in the Williston, I would say there’s 10 times the variability and quality [in the Permian] too. Inflation has really narrowed the difference in economics. We’ve been about 50:50. That means the Permian’s still growing while the Bakken makes up about a little over 60% of our business.
“We at Northern would welcome a modest pullback in oil prices. But I can also tell you, I can see a scenario where oil just keeps marching up and testing until it gets to a price that finally tips everything over.”
But it’s been a pleasant surprise. I think we’ve also learned some stuff. We have changed. A lot of the Permian operators structure that ground game development differently. It doesn’t really change the economics for us, but just the way the contracts are structured, we’ve actually started putting that same structure into some of our Williston transactions. And it’s just a way of how we account for it that makes it less kind of herky-jerky in terms of the capital. It basically smooths it out into the development path.
DB: What’s your view of oil prices and their sustainability? Recently there’s been a selloff in the market, though analysts don’t see strong evidence of demand destruction yet.
NO: In 2008 [during the Financial Crisis], the market was equally tight. When the financial crisis started to gain momentum and the dollar started strengthening, oil went from $140 to $25. And overall worldwide demand went down, maybe a half a million barrels a day for about six months. My point being, that markets view scarcity and oversupply in extremes.
If the financial markets start to tumble, it will just be like a seek and destroy and oil will eventually get its comeuppance. Now if oil was to crack from here, do I think it's going back to $25 or $40? The realities, inventory drain and the Russia problem probably means that the downside is $70. But to think it’s not possible—I’ve seen it. People tend to think on an evolutionary basis where, after a while, if something becomes viewed as sticky they kind of forget all the risks.
It’s been a long time since we’ve had a really bad market. We at Northern would welcome a modest pullback in oil prices. But I can also tell you, I can see a scenario where oil just keeps marching up and testing until it gets to a price that finally tips everything over. I could see it go to $150 a barrel, $180, some crazy price in order to effectively stamp out demand. That's sometimes that's how markets work.
So, it’s not really demand destruction, but ultimately just that the economy kind of burns itself out. I can see a scenario in the next nine months where the cure for high prices is high prices.
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