“The A&D market is dramatically different than a year ago.” Scott Richardson, principal with Houston-based asset marketer RBC Richardson Barr, was one of four panelists who recently addressed an audience of more than 500 upstream business development professionals at Oil and Gas Investor and A&D Watch’s A&D Strategies and Opportunities Conference in Dallas.
A confluence of drivers has created a whirlwind of A&D activity in 2008.
Deal flow as of the first week in September was on a record pace. Some $35 billion in assets have already been sold in 2008, compared with 2007’s total of $45 billion and a typical year-todate in which $10- to $15 billion would be the norm, he says. By the end of the year, “we anticipate another $20 billion of deal flow. This is going to be a $55-billion year in terms of assets.”
Why has it been such a busy year? Fear of change, says Richardson. For one, private companies that have historically never sold are selling this year to lock into a 15% capital gains tax rate, fearing that a changing administration in Washington, D.C., might increase the rate.
Also driving the market: a wave of private-equity-backed companies going to market ahead of schedule to capture value from record commodity prices.
“Look at the private companies and the private-equity guys and that’s why you see the market so busy right now,” says Richardson. “There are a lot of assets for sale.”
Shale shock The majority of A&D activity this year is due in some way to oil and gas shale resource plays, says Bill Marko. Marko is managing director of Houston divestment firm Jefferies Randall & Dewey. Some companies are making targeted acquisitions to get into shale plays, and others are divesting non-shale assets to raise capital to support shale-development programs.
“Gas shales are what’s going on in the market right now.”
Hundreds of millions of dollars are being spent on land deals presently, and not all are public, he suggests. Not counting land acquisitions, more than half of all A&D activity this year has been in the gas shales, according to Marko, and including the Bakken oil-shale play, some two-thirds of all deals involve unconventional shales.
Large-cap companies dominate the space. “If you look at the Haynesville, Woodford, Fayetteville and Marcellus,” says Richardson, “almost 100% of the buyers are large-cap companies. We do not see big public companies buying conventional—we see them focused solely on resource plays.”
The flood of deals coming to market from these plays is becoming problematic, he says. In East Texas and northern Louisiana, 10 deals with Haynesville potential in excess of $100 million are on the market currently. “Anybody that has a Haynesville acreage position is coming to market now as opposed to drilling, so we’re seeing a lot of deal competition. We’re also seeing that in the Marcellus.”
The number of proved undeveloped locations (PUDs) being amassed in the shales and the capital required to develop them will drive A&D in the years ahead, Marko says.
“It’s a huge reserves accumulation that’s going to require a lot of capital. If you look at the number of wells to be drilled, it will take $800 billion to develop.” A portion of the funding will come from a combination of public equity, debt and private equity, but most will come from acquisitions and joint ventures, he predicts.
“Everybody in the shales has got to raise money.” Of the $10 billion raised in public equity this year, more than half has been for shales. “Think about $10 billion vs. the ultimate $800 billion. That’s just a tiny amount.”
Private-equity funding will continue to be interested in the shale plays, he says, and big-ticket joint ventures like Chesapeake Energy’s 20% sell-downs to Plains Exploration & Production and BP Plc in the Haynesville and Fayetteville plays will become commonplace.
“There’s going to be a lot of money moving around to develop the shales. Consolidation is going to carry on for quite a long time.”
Matt Meagher, president of Denver oil and gas marketer Meagher Oil & Gas Properties Inc., says companies that have amassed such large land positions in plays such as the Bakken, Barnett and Haynesville will have no choice but to take on partners. “There’s no way within the next three to five years they can HBP (hold by production) enough leases without bringing in partners with more rigs and more capital.”
The urgency of acquiring and developing these positions in the shale plays has kicked off assets into the marketplace as well.
“You’re going to see more and more sales of non-shale assets by companies to raise money for their shales,” Marko says. He again points to Chesapeake, which has sold three volumetric production payments, and to Forest Oil’s plans to sell $1 billion in assets, to pay for shales. “You’ll see the Chesapeakes of the world selling non-shale stuff.”
Richardson agrees. “With the capital markets closed right now, we’re going to see a bunch more public companies selling their conventional assets to fund their Haynesville, Woodford and Fayetteville. The shale plays are just so capital intensive and nobody wants to raise equity right now. You’re not going to see XTO Energy or Chesapeake raise equity, so we’ll continue to see asset sales.”
Foreign interests Appealing valuations due to a weak dollar, troublesome political environments abroad and tempting reserves domestically have turned the eyes of international companies stateside.
Some 25 non-U.S.-headquartered companies have operations in the U.S. and, based on ongoing discussions and the signing of confidentiality agreements through his firm, up to 40 new entrants are looking to do deals in the States, according to Adrian Goodisman, Scotia Waterous co-head U.S. and managing director.
Many have set up beachheads in the deepwater Gulf of Mexico, where more than 90% of the transactions in the deepwater in the past three years have been dominated by international companies, primarily European and Asian.
Transactions on the Gulf of Mexico shelf, in contrast, lean heavily to U.S. companies, which accounted for more than 80% of the dollars spent in 2007. Still, Asian companies have been successful in growing positions on the shelf, says Goodisman. Earlier in the year Korean companies Korea National Oil Corp. and Samsung Corp. bought Taylor Energy for more than $1 billion. Other examples of successful Asian shelf players include Mitsubishi, Nippon, Mitsui and Sojitz.
“These guys have established positions here and are steadily growing their businesses, not just on the shelf, but moving onshore as well.”
While onshore the lion’s share of transactions are dominated by U.S. companies—about 90% of the value—internationals have made inroads. Canada’s EnCana Corp. made a big impression with a $2.5-billion acquisition of Leor Energy late last year. Israeli-headquartered company Isramco bought GFB Acquisition, which had assets in the Permian Basin, East Texas and southern Louisiana.
“More and more international companies are looking to do transactions onshore,” Goodisman says. A Korean company, for example, was a recent runner up on a “several-$100-million deal” in the Rockies.
A stable rule of law in a politically volatile world market and a good fiscal regime that provides cash flow more quickly are two primary reasons international companies are targeting the U.S., but the primary driver is access to large reserves.
“Originally, many foreign companies focused primarily on the deep water, but now we’re seeing more focus on the onshore.” He points to BP’s two very large transactions in separate shale plays. “You’re going to see many more like this.”
Onshore U.S. resource plays are akin to the oil sands in Canada, he says, because both involve “big reserves and big capital.” Canada’s oil sands drew the attention of the Chinese, Japanese, Koreans and Europeans. “You’re going to see the same thing happening now with these big resource plays onshore U.S.”
Many international companies hold an advantage due to a lower cost of capital than some of the U.S. companies. “Quite often, when they are bidding and particularly when they are looking at their first entry point, they’ll add a strategic premium to that number they are going to bid to be successful.”
What does it mean for U.S. companies? “There’s going to be more competition for U.S. companies to be successful in the U.S.,” says Goodisman.
The money trail Buyers are armed with $55 billion in funds for acquisitions, according to Richardson, a drop from the $70 billion that was chasing $45 billion in assets in 2007 but is now in a one-to-one balance.
“This is the first year we’ve been in equilibrium over the past three years,” he says.
Because commercial banks have tightened credit over the past year, public debt available for acquisitions has dropped from $30 billion to $20 billion. Private equity is about the same as the previous year with $35 billion available.
“The most dramatic change in the market today is capital,” Richardson asserts. Over the past five years too much capital has bombarded the market, about $2 for every dollar of assets. But with public debt and equity markets softening, “we’re not seeing the capital availability for deals that we’ve seen in years past. There’s still a lot, but for right now it’s a little tighter than it has been. Clearly, the private equity market is the most robust market right now.”
But private-equity companies have been fairly quiet thus far this year, he notes. With $20 billion of assets coming to sale in the fourth quarter and serial acquirers XTO and Chesapeake suggesting they are moving into digest mode, Richardson expects private equity will step up. “Private equity will be buying a lot of these big deals.”
Matt Meagher believes abundant capital availability is the primary driver behind the fervent deal flow.
“There’s more money in this space than we’ve ever seen before. Not too many years ago a $50-million transaction was considered sizeable; now it’s barely noteworthy. Multi-$100-million transactions are more common. I see more capital in the market driving competition and transactions.”
XTO has dominated the acquisitions market this year, accounting for 67% of the buyer’s market with $11 billion of the first $30 billion. Richardson says, “XTO has been the market this year.” Too, “dormant buyers” have emerged—companies that historically have not been asset buyers but that realize they need to acquire assets to meet production targets.
One significant difference in the marketplace this year is the master limited partnership (MLP) sector, which has acquired less than $1 billion in 2008, compared with $10 billion in 2007 and in which five of the top 10 acquirers were MLPs.
“In 2007 MLPs were 20% to 25% of the market,” Richardson says. “This year we really do not see the MLPs having a huge influence on the buy side.” Not a lot of capital is presently available for MLPs, he says, and the sector will likely get worse before it gets better. “There are some terrific MLPs out there, but right now we’re not seeing them competitive in bid situations.”
Major players? The majors are coming back onshore North America.
Two major integrated players are already in the fray. The U.K.’s BP Plc planted its feet firmly in the Fayetteville and Woodford shales in two deals from Chesapeake for $3.7 billion. And The Netherlands’ Royal Dutch Shell through subsidiaries made a big wave in British Columbia with a $6-billion purchase in the Montney shale and has accumulated 325,000 acres in the Haynesville shale in a joint venture with EnCana.
Every single major is now coming through A&D data rooms, according to Richardson. The global sandbox has gotten so small with operational challenges in oil-rich regions such as Russia, South America and West Africa that the majors have to come back onshore North America where it is politically secure.
“We’ve seen BP and Shell make a lot of acquisitions this year in the U.S. We’re going to see all of them. That’s a theme we’re going to see for the next couple of years.”
That these two majors are in the top five U.S. acquirers this year is momentous, says Marko. These fall in behind XTO, Plains and Chesapeake in a ranking that includes land acquisitions and lease sales.
“The majors are coming back to the states for lots of reasons,” he says. “The majors used to set the food chain. When they were exiting they created the market and the supply of properties. Now they are buyers as they re-enter the U.S.”
The bait? Large reserves in North American shale plays. “All the majors are looking at the shales really hard. Their challenge is how to execute in it—can they set up an organization that is going to drill 2,000 wells in the shales with 50 rigs? They are more used to deepwater developments or something in Angola.”
And should the majors decide to jump into shale plays feet first, existing companies with large positions that have executed their programs may be ripe targets. “That makes them potentially very attractive partners or attractive acquisitions if majors can value the upside enough to pay a premium to cause a deal to happen.”
Softer commodities After reaching highs of $143 per barrel for Nymex oil and $12 for Henry Hub gas, commodities prices took a gut-wrenching dive in July. What impact has softening prices had on A&D?
“We’re not seeing a dramatic impact on oil,” says Richardson “When oil was $140 a barrel, we didn’t see the strip being fully valued.” Instead, many acquirers topped out at $120 to $130 per barrel when valuing assets, he says. Now, “they are honoring the strip, so we’re not seeing a dramatic decrease in oil valuations.”
Natural gas transactions, however, are a different tale, particularly in the Rockies where huge differentials have opened up, driving down asset valuations. “High-quality PUDs (proved undeveloped locations) are still terrific in getting value, but some of the lower quality PUDs are starting to be uneconomic at $7 gas.”
Rapidly moving commodity prices—whether ramping up or down—don’t encourage A&D. “Sustained high prices are good for our business and sustained low prices are good for our business,” Goodisman says, “but when you have volatile prices, its hard to get buyers’ and sellers’ expectations to match.”
Softening commodity prices have led to a number of failed sales, as well. Richardson points to Encore Acquisitions as an example. When it announced it was seeking strategic alternatives in May, oil was at $140 per barrel and its stock was trading at $70. By July, when the company abandoned the effort, oil had fallen to $110 and the stock $48.
“Obviously, a deal is not going to happen there. Until we have stability of commodity prices we’re going to have very little (corporate) M&A in the near term.”
Contango Oil & Gas is another example, which put its prolific Gulf of Mexico Dutch and Mary Rose discoveries on the block hoping to capitalize on the high-flying commodity prices. But when the strip price for gas dropped to $8.50 per thousand cubic feet, Contango too pulled the plug on the sale.
Says Marko: “There are probably a couple of dozen sales out there that are stuck right now. We’re going to see more stranded deals than we’ve seen in awhile.”
The memory of record commodity prices has caused a number of sellers to have expectations stuck too high, Goodisman says. Sellers offering 5% to 10% proved developed producing (PDP) assets and a lot of PUD dots on a map may think they’re going to get the moon, “and sometimes they do. But not all PUD locations are equal.” Some sellers have very high expectations “and they’re not always getting what they want.”
Richardson sees a regional theme in the recent trend of failed deals. Many are occurring in the Gulf Coast, the Gulf of Mexico and the Rockies, he noted. He says 90% of all transactions are sold to a “fly” bid—a bid that is 20% ahead of the pack. “If a serial basin acquirer is not in the acquisitive mode and you don’t have that flyer, you sometimes will have failed deals.”
He pointed to lingering high seller expectations in the Rockies in particular leading to failed sales there. “Differentials in the Rockies are killer right now.” A $9 strip price with netbacks of less than $5 makes it “very difficult” to close deals.
Hidden opportunities So where do hidden opportunities lie in today’s A&D marketplace? Competition is less for packages valued below $75 million, says Goodisman, “and over $1 billion the crowd thins out, too.”
Richardson notes that sub-$50-million deals are not pricing as robustly due to a shortage of engineers and geologists not being available to evaluate the smaller-sized deals. “The little ones are not getting reviewed,” he says. Also, “we struggle to find buyers” for low PDP, nonoperated assets.
Marko emphasizes that it’s a great time for private-equitybacked companies that are regionally focused, specifically in one sub-basin such as Louisiana, California, South Texas, Oklahoma, the Permian Spraberry or the Gulf of Mexico shelf.
“Everybody’s running to the shales with the bigger companies and the big money,” he says. “These guys are going to be scouring the non-shale plays looking for deals, and that is where the food chain will go.”
A unique opportunity exists in East Texas and northern Louisiana right now for non-Haynesville players, says Richardson. Most of the packages coming available in the Ark- La-Tex region separate the deeper Haynesville rights from the shallower rights.
“A lot of the big companies are just bidding on the Haynesville. For the guys that are comfortable with Cotton Valley and Travis Peak, there’s going to be a unique opportunity over the next months to bid just on these shallow packages.”
Meagher says he foresees alert larger companies taking advantage of undervalued stocks of smaller companies. “They will try to take them out that way versus asset sales,” he predicts.
As the year winds down, Richardson predicts the fourth quarter will be interesting. “There’s going to be a lot of deal flow. It’s going to be one of the most active fourth quarters we’ve seen in a long time.”
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