Ryan Keys, CEO of Midland Basin operator Triple Crown Resources LLC, considers himself something of a taco expert.

At Oil and Gas Investor’s A&D Strategies and Opportunities conference in Dallas in September, Keys launched into a brief analysis of a hypothetical taco shop deal.

Keys’ Taco stand theorem goes like this: combine one taco stand with another similar stand. The rationale: the buyer pays less for his pork supplies.

Lower pork prices, combined with some streamlined general and administrative (G&A) costs, lowers Triple Tacos’ costs, and his investors should be happy.

His example of successful taco stand A&D resonates across companies engaged in transactions, including E&Ps.

The goal, perhaps since Ancient Greece, Mesopotamia or the Neanderthals’ wooly mammoth market, is to pay less to make something while selling it for the same price, Keys said.

For E&Ps, that reasoning would seem even easier to grasp for investors than “some esoteric geological reason” for doing a deal, he said.

“This is very basic stuff. Keep revenue flat, reduce input costs and then I make more money. This should work for E&Ps, right?”

Keys’ answer to his own question: “No.”

Underpinning Diamondback Energy Inc.’s August $9.2-billion deal to buy Energen Corp. was lower cost and reduced G&A expenses.

The response: a 10% sell-off in Diamondback shares. Upstream A&D dynamics have changed, perhaps irrevocably, since the downturn. Presidio Petroleum LLC founder and co-CEO Will Ulrich said that A&D buyers returned in 2017 to find a market “totally different from [that of] 2012 to 2014.”

“There was some inability from the market to observe that. The result was a lot of failed deals, a lot of broken deals,” he said.

Panelist Kyle Mork, CEO of Greylock Energy LLC, warned that private-equity-backed companies must exercise patience and achieve scale. Thinking in pre-downturn terms of drilling and dealing is dangerous.

“The days of drilling out a little bit of the acreage and flipping for a lot of value are just not there now, and I kind of doubt they’re going to return in a meaningful way,” he said.

The current oil and gas market’s short-sightedness could hurt public companies’ ability to compete as opportunities come, the speakers said.

“Something has to give,” Keys said, adding that the current way acreage is being discounted to PDP assets is creating a “gigantic chasm” between cash-flow values and reliance on EBITDA.

“Who’s going to step in if this continues? That’s too big an arbitrage to just leave there and not do anything about it,” he said.

Permian deflation?

Investors continue to be “hyper-focused” on free cash flow, even as some companies have to spend to grow, Keys said.

That means companies are being “absolutely hammered regardless of how good their assets are.”

Keys analyzed the performance of 20 Permian-weighted companies’ 2018 EBIDTA and capex. Nearly all of those companies’ free cash flow will remain negative through 2018, he said. Permian E&Ps managing to show roughly neutral free cash flow have seen a 30% higher enterprise value than the basin’s out-spenders.

Historically, outspending wasn’t necessarily a bad thing “as long as that external financing was used to make economic wells and grow production,” he said.

But the market has also developed a case of myopia. Even E&Ps that have demonstrated a “legitimate line of sight to free cash flow in 2019 aren’t being rewarded for that or really anything, for that matter,” Keys said.

Even with promising 2019 EBITDA guidance, the market continues to trade based on 2018 free cash flow.

Before Diamondback was thrown under the wheels of the Wall Street bus, the company said its deal with Energen might produce synergies of between $2 billion and $2.6 billion.

Keys argues that only two metrics—the taco stand basics—need to be believed in order to see the Energen Corp. deal as a win for Diamondback shareholders.

“Diamondback is in fact spending about $200 per lateral foot less on its Midland Basin wells,” he said. “That works out to about $2 million for a 10,000-foot lateral [on Energen’s assets]. So it’s pretty easy to understand.”

Diamondback horizontals in the last year have also burrowed about 800 feet deeper than Energen’s.

“So, their drilling costs and hydraulic horsepower requirements, all things being equal, are going to be a bit higher,” he said.

While Energen uses more sand and water for its wells, those completions aren’t enough to seriously affect the projected savings, he said.

Looking at the numbers another way, Keys plugged in Diamondback’s well costs into Energen’s holdings going back to Jan. 1. He also subtracted about $30 million in G&A costs that appear reasonable based on the Diamondback-Energen combination.

“That moves Energen immediately into cash-flow neutrality this year,” Keys said. “Right now.”

Keys paused to remind the audience that companies that are free-cash-flow neutral are “worth about 30%” more than out-spenders.

Yet for Diamondback, that didn’t happen.


For at least 2,700 years, philosophers, political thinkers and bestselling business writers have looked at behavior through two archetypes represented by the fox and the hedgehog.

Each animal’s characteristics convey the benefits and extremes of risk and retreat, leadership styles and strategy.

“The fox, as you’d expect, is quick, cunning, creative, always moving around,” Keys said. “It might lose focus every once in a while.”

The hedgehog really needs to do one thing extremely well in order to survive: curl up into a ball when in danger.

“It’s not a stretch to apply this concept to investing, particularly in oil and gas,” Keys said. “As with anything, balance is important.”

Keys said the immediate reaction to the Diamondback-Energen deal may mean investors have reached “peak hedgehog” in the outlook.

“The inability of the public to come out of its protective ball of quills is getting almost comical,” he said.

It also creates opportunity for buyers. If enterprise values remain flat into 2019, acreage will be worth less—perhaps one-fifth of what it is now—while PDP continues to command value.

The gap in values will make it more difficult for public—and private—E&Ps to attract capital. Private company Triple Crown, Keys said, can execute flawlessly, prove up new concepts, but “we are effectively pushing on a rope until publics can pick up that slack.”

In April, Triple Crown, backed by Yorktown Energy Partners, acquired Broad Oak Energy II’s assets in Irion County, Texas, in a deal worth more than $400 million. Broad Oak is backed by EnCap Investments LP.

“Historically speaking, it was unusual” for two private-equity-backed companies to buy one another.

“Going forward, it may become more commonplace,” Keys said. “This is really a perfect time for private capital to step in and acquire some really good assets that the publics just can’t.”

Public companies indeed seem reluctant to execute traditional deals.

In Greylock’s Marcellus and Utica positions, mid-level company executives lack the authority to sell, but trades are increasingly welcome as a way to high-grade acreage.

“The funny dynamic from my perspective is that it’s a lot easier for big public guys to swap acreage than it is to sell it,” Mork said.