The Ins and Outs of Nonop Working Interests

Presented by:

This article first appeared in the 2022 Minerals Business Report and Buyers Directory. 

Companies active in the oil and gas and minerals spaces alike are looking at a variety of strategies to optimize their businesses, spurred by the volatility in the oil market in recent years.

Some companies have pursued both E&P and the acquisition of mineral leases or are exploring hybrid approaches that tie both together. Chris Cottrell, an associate at law firm Winston & Strawn, cited Black Stone Minerals and Viper Energy Partners as examples of such hybrid approaches that have emerged in recent years.

Some companies have opted to focus on nonoperated working interests on the E&P side of their businesses while also engaging in activity on the minerals side. Such a focus on nonop interests comes with certain risks but also certain opportunities.

Cottrell told Hart Energy that the lack of control was one of the main challenges for nonop players.

“You don’t have control over what the operator wants to do with respect to development,” he said. “The most typical situation is the operator proposing the project, and you just have the right to consent or not consent to it.”

He added that companies that own nonop interests tend to be smaller, with less access to capital markets than larger operators.

At the same time, though, there are opportunities to be found with this approach, and a number of companies consider the opportunities to outweigh the risks. Those seeing benefits to pursuing a nonop strategy specifically include Ventana Exploration and Production as well as Accelerate Resources.

Accelerate’s approach

Accelerate describes itself as a technology- and data-driven company, focused on the pursuit of fractional working interests and minerals in the Permian Basin.

“Our company was founded in 2016 to take advantage of a dislocation we identified in the oil and gas market— that small, fractional ownership interests were overlooked by the industry at large, and there was an opportunity to aggregate them into a large, cash-flowing, diversified portfolio of scale,” Brennan Potts, Accelerate’s founder and CEO, told Hart Energy. “Our solution was to build a proprietary technology and data-driven process to identify, acquire and manage financial-oriented assets on behalf of leading institutional investors.”

The company opted to focus on the core of the Permian because that was where it saw some of the industry’s best risk-adjusted returns. Since 2016 it has participated in drilling more than 1,000 wells in the basin, while establishing relationships with operating partners and a network of potential sellers.

“While nonop interests had been around the oil and gas industry for some time, we saw an opportunity to pioneer a new type of asset class in aggregating fractional working interests in premium areas in the Permian to build a diversified portfolio of the best wells,” Potts said. “This worked favorably for us because our exposure to any one well or interest is typically less than 10%, which greatly reduces our risk.”

Potts sees the biggest challenge in the space as navigating volatility, whether that volatility comes in the form of commodity pricing, cost assumptions or development timing.

“Our solution to this challenge is to build a diverse portfolio of core resources that can generate both free cash flow and growth that are largely uncorrelated with broader market conditions,” he said. “We then leverage our experience, relationships and dataset to help us make faster and smarter decisions.”

The COVID-19 pandemic also added to the challenges faced by Accelerate and others, though some of these are now easing as oil demand and prices pick up.

“The biggest challenge during the pandemic was calibrating the right value for new deals in such a dynamic pricing environment,” Potts said. “After a pretty slow year in A&D in 2020, we are now seeing a good deal of competition for a smaller set of available deals across the board.”

“After a pretty slow year in A&D in 2020, we are now seeing a good deal of competition for a smaller set of available deals across the board.”

—BRENNAN POTTS, Accelerate Resources

Ventana’s strategy

Ventana, a private equity-backed firm that was also founded in 2016, is focused on acquiring nonop interests across Oklahoma. The company states on its website that its nonop strategy is unique and that it seeks to offer favorable deals to mineral and leasehold owners. Ventana has pursued opportunities related to the dynamics that have played out in the oil patch over the past few years.

“Since the inception of Ventana, there have been numerous tailwinds that have affected our industry, including capital constraints in the space,” Ventana’s president and CEO, Heather Powell, told Hart Energy. “This has given us an advantage in the nonop space to partner with operators to reduce their exposures or diversify their interests so that their dollars are focused on keeping their rigs in core areas.”

Powell believes there are currently a lot of opportunities, both for Ventana and other companies in the same space.

“There will continue to be consolidations, so being disciplined and focused on the short- and long-term goals of the company is extremely important,” she said. “Ventana is always in acquisition mode, but it is important for our team to constantly be evaluating our portfolio to ensure we consider divestitures as well. We have strict guidance for diversification given the nonop strategy, so working with peers in the same space to work trades or sell-downs has also been very important to us.”

Additionally, Powell sees opportunities in working with both operators and other nonop companies to pursue common goals.

“When we work together to achieve our respective and common goals, more development happens, less regulatory filing delays and costs are reduced,” she said.

Powell acknowledges that there is “definitely” risk in working interest ownership, and Ventana has various ways of mitigating that risk.

“We are committed to our exposure limits to remain diversified, have a strong hedge book and a consistent approach to underwriting projects to avoid taking on any unnecessary risk,” she added.

The company is also navigating the changes that have resulted from the recent volatility in the oil market.

“Pre-2019, operators were focused on having 100% exposure to their drill program, spending budget dollars on their nonop, and it just wasn’t sustainable when commodity prices crashed and bank loans called,” she said. “I don’t think anyone wants to ever be that leveraged again, so finding the right mix of debt, living within cash flows and determining a capital budget focused on respective core projects is critical to success and, at times, survival.”

“Finding the right mix of debt, living within cash flows and determining a capital budget focused on respective core projects is critical to success and, at times, survival.”

—HEATHER POWELL, Ventana Exploration and Production

Looking ahead

While the oil and gas industry is benefiting from higher prices and demand, the headwinds are unlikely to be over and there will be further challenges to contend with. Winston & Strawn’s Cottrell pointed to cost inflation as being among those challenges.

“Even though commodity prices go up, your costs of doing business go up as well,” he said. This is particularly the case in the context of unconventional development, which requires continual capital investment to maintain production, he explained.

“In that context, it’s difficult to maintain your margins or increase your margins,” Cottrell said.

However, he sees this as presenting an opportunity for nonop players.

“The phrase that people use is ‘developing within cash flow,’ and that’s a huge focus right now. But, obviously, that makes nonop interests a lot more attractive,” he said.

“If development is slowing down and there’s now a lot more focus on fiscal responsibility, then in my mind, the asset class becomes a lot more attractive, because at least you have a much higher likelihood of having a partner that is economically rational.”