DALLAS—Sanchez Energy Corp. (SN) proved its agility during the upturn in oil and gas as it transformed 92,000 Eagle Ford acres and 10 wells generating 600 barrels of oil equivalent per day and $15 million in revenue into a quarter million acres, 53,000 barrels of oil equivalent and $600 million in revenue in just four short years.
Doing so required both financial creativity and delivering a solid track record of execution in the field to convince Wall Street that the small cap independent had the right acres and the right people to maximize its Eagle Ford assets in a capital intensive shale development program.
Now, eyeball to eyeball with the downturn, Sanchez is developing ways to financially engineer balance sheet staying power while working the cost and capital efficiency angles not only to navigate through tough times, but to position the company for renewed growth when the business climate improves.
Sanchez grew through an aggressive acquisition asset program that saw deals with Royal Dutch Shell Plc (RDS-A, RDS-B) and Hess Corp. (HES) but also experienced expansion organically through the drillbit. Acquisitions also provide opportunity in a down market.
“Now is a really good time to get your house in order to do acquisitions,” G. Gleeson Van Riet, chief financial officer for Sanchez Energy, told attendees at Hart Energy’s A&D Strategies and Opportunities Conference in Dallas. “If you can make good money buying good assets during boom times, you can make great money if you can buy good assets in down times.”
By selling production after well payout, Sanchez Energy Corp. brings value forward to reinvest in its capital program. The Houston-based independent typically sells interest in half its production after a well has been on line for two years with the buyer’s interest escalating to 100% after five years. The rising interest offsets the decline curve and the seller realizes stable production through the arrangement and can pay a higher price for the production.
Sanchez financed acquisitions during the upcycle by doing long-term financial deals from multiple funding sources and overfunding the transaction. Not only could Sanchez buy the asset using this method, the company also had capital to drill prospects. During the upcycle, Sanchez avoided drawing down bank debt and focused on long-term high yield debt, which they acquired at or near historical low interest rates.
Whether in an upturn or a downturn, the challenge for small to mid cap companies in tight formation production is self-funding the developmental ramp. Sanchez’s strategy involved earning pay out on newly drilled wells in 12 to 24 months at the front end of the decline curve, then selling the long production tail to another entity and re-investing the capital in new drilling.
Sanchez looks at the mid-cycle point of a well’s life between the steep decline early in a well’s history to the MLP-attractive shallow decline tail as the well matures. The Houston-based independent offers a 50% interest in wells after pay out while production is still high. That interest grows to 100% at the end of a five-year term. The technique means a buyer can count on a steady production profile during the course of the payout as its position expands, offsetting the decline rate. That opens an option in which a buyer can leverage the production independently, and pay a higher overall price than what would be involved in a straight sale.
As a seller the strategy frees Sanchez from accessing the equity and bond markets, which have tightened when it comes to energy, while sidestepping the challenges of bank debt redetermination every six months.
The second side of the coin is capital efficiency and the ability to lower field costs. Initially Sanchez called suppliers and attempted to negotiate lower costs. As the downturn intensified, the company embarked on a strategy to push decision making to the lowest level possible when it came to contract re-negotiations. The message to both employees and vendors was that Sanchez would not drill wells that didn’t make money.
If it meant switching out suppliers to get there, Sanchez engineers had that option. Sanchez began de-bundling vendor services. For example, de-bundling might mean renting the horsepower to fracture stimulate a well while turning to a logistics company to run a truck fleet to transport sand. It also meant self-sourcing sand and chemicals. De-bundling brought the lowest delivered price for discreet services.
The second strategy involves demand planning as the industry evolved from needing equipment and services on demand during the boom to coaxing a vendor to offer the best price if work is scheduled well in advance. Those two strategies are augmented by a third in which Sanchez is purchasing ancillary equipment to meet well site needs such as trailers, generators are storage tanks, which are now cheaper to buy than to rent.
“We find there's a lot of oil field suppliers in these downturns who are actually quite happy to sell stuff, good, usable equipment, at pretty good prices, because they need capital, Van Riet said. “So that's a way we lock in more of these prices in a downturn.”
Contact the author, Richard Mason, at firstname.lastname@example.org.
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