Oil and Gas Evaluation Report : Oil & Gas Evaluation Professionals : Obsidian Energy Company : · Seismic Interpretation, Petroleum Engineering

Scotia Waterous recently published their "Fourth Quarter 2010 U.S. Market Review" which contains some interesting information and observations on the state of M&A activity.   

"The fourth quarter exploded with M&A activity, highlighted by several high profile
shale transactions. A total of 54 transactions worth approximately $27.4 billion were
announced during the quarter, which was more than triple the previous quarter. Once
again the focus was on shale assets as approximately 72% of announced transaction
value during the quarter was attributable to this unconventional resource. Producing gas
asset multiples continue to trend downwards in the prolonged low commodity price
environment. In the fourth quarter, reserve metrics dipped as the majority of
transactions involved long life, gas-weighted assets. For example, EnerVest/EV Energy
acquired Talon's Barnett Shale assets for $0.91/Mcfe in a $967 million transaction.

"Public corporate transactions accounted for 36% of fourth quarter activity. EXCO
Resources received an offer to be taken private by management and Chevron acquired
Marcellus Shale focused Atlas Resources, giving the major its first significant shale
acreage position as it follows in the footsteps of other majors like ExxonMobil (XTO) and
Shell (East Resources). Oil-rich shales like the Bakken and Eagle Ford were also very active
during the quarter, with several high profile joint ventures and acreage transactions.
CNOOC, a Chinese national oil company, acquired its first onshore U.S. assets through a
$2.2 billion joint venture in the Eagle Ford with Chesapeake. Statoil and Talisman entered
into a joint venture and acquired Eagle Ford player Enduring Resources for $1.3 billion,
and Occidental, Hess and Williams acquired a combined $3.3 billion of acreage from
private companies in the Bakken Shale. Other notable transactions during the fourth
quarter included Occidental acquiring a large South Texas gas package from Shell for
$1.8 billion and Energy XXI acquiring a $1.0 billion oil-weighted Gulf of Mexico Shelf
package from ExxonMobil."

I am constantly being asked by potential oil and gas investors if there is a way to quickly "size up a deal" to determine its value.  As I have warned in past articles, these "rules of thumb" that many use to ball park a deal size can be dangerous because no deal ever seems to be standard, and there are always special circumstances which need to be considered when determining the value of an asset.  That being said, Scotia Waterous has provided historical graphs of some of these ball park yardsticks that can be used to get an idea of the value of an asset.  As you can see from these exhibits, the type of asset (long life, short life, percent liquid, etc) and its location have a major impact on the value of an asset.

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The August 2010 issue of JPT (official publication of the Society of Petroleum Engineers) features a guest editorial by Michael Collier, Partner, Houston Transaction Services Group, PricewaterhouseCoopers in which he makes several interesting observations about the current state of M&A activity and speculates about future activity.

“One sure sign that the economy is in recovery mode is the increase in merger and acquisition (M&A) activity, including the USD 60 billion of deals in the energy sector in the first quarter of 2010. The depth and breadth of the M&A rebound in energy has been fueled by optimism that we are emerging from a global financial “funk” and we are at the beginning of a long period of sustained economic growth.”

Mr. Collier goes on to credit the resurgence in M&A activity to “pent-up demand” and the new “shale-gas paradigm.” He also credits the recovering stock market for leveling the playing field and “allowing senior executives to see stock-for-stock deals as fair.” “Until recently, it was difficult for both buyer and seller to see any particular acquisition price as the right price because earnings of target companies were declining. As the overall economy improves and sellers report steadily improving quarterly earnings, price expectations between buyer and seller are coming into line.”

As for the future, Mr. Collier predicts “When [price expectations between buyer and seller] are finally aligned, which often happens four to five quarters after the economy begins to recover, then we will see not only corporate cash-for-stock deals become common, but we will also see private equity firms come off the sidelines with a major wave of transactions.” However, he also sees some changes in the way deals will be evaluated, “Given the changing economic variables, and some lingering uncertainty in the capital markets, deal-making experience and savvy will be a valuable ‘commodity’. Our corporate clients are starting to recognize these challenges and are making changes to the way they pursue deals. In fact, we have seen them work hard at getting smarter and in some instances, they are adopting some of the skill sets of petroleum engineering firms to better compete and succeed.”

Mr. Collier sees shale-gas as a potential game changer. “Not only does it create the possibility of a dramatic change in the hydrocarbon supply/demand equation, but it has driven and will continue to drive M&A.” Shale-gas has indeed impacted the US energy industry for a number of reasons and Mr. Collier comments on one of the more interesting aspects, “…the rush to exploit shale gas has also triggered a rush to acquire oil reserves. Although this new ‘oil rush’ surprised many industry observers, it now appears quite logical. With gas prices likely to remain flat (given the tremendous gas supplies found in the shales), there is a new expectation that independent oil companies in particular will be rewarded for oil reserves in the portfolios in the intermediate term.”
 

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It seems like hardly a week goes by anymore without two large oil and gas companies announcing a new JV. Most of the recent JV announcements involve the development of new, hot shale plays. Chesapeake Energy is certainly one of the leaders in this development concept and has announced several different JVs covering most of the current unconventional shale plays, with some very large partners.

Why the interest in a JV? There are several reasons a JV is attractive to the parties involved on both sides of the deal. From the originator’s (or seller’s) side the JV raises capital, allows for the diversification of development (spreads the risk), and leverages-up the returns on the development investment by virtue of the “promote.” From the partner’s (buyer’s) side the JV is a means to enter a hot new play that has been delineated without having to participate in the “land rush” that always precedes these plays, and provides instant access to experienced personnel thus reducing time on the “learning curve.”

With the various unconventional shale plays that have heated up, from the Eagle Ford to the Bakken to the Marcellus and everything in between, there is a common timeline that begins with companies and promoters secretly buying up leases; this requires a lot of time, effort and money. This lease bonus money is at risk because the play is in its infant stage and the acreage you are leasing up may turn out to be non-productive, or the play itself could fizzle out. Companies like Chesapeake and EOG (and others) have taken these upfront risks along with the time and costs associated with developing the drilling and completion expertise specific to each play, but then face the capital requirements necessary to develop their leases. The capital necessary to develop these plays is staggering with costs ranging from $3-10 million per well (more in some cases). Even with companies this size, drilling 100 $10million wells can put a strain on your cashflow.

The company “selling” the JV usually gets a cash payment upfront that allows them to recoup these out of pocket costs and provides capital to continue their development program. The other aspect of the JV is the “promote” which allows the “seller” to develop the asset at much more favorable terms and with less capital. Some of the recently announced JVs have “promotes” on the order of 60% for 25% (Chesapeake/Total Barnett), or 75% for 45% (Pioneer/Reliance Eagle Ford). This means the “buyer” pays for 60% of the drilling costs in exchange for 25% of the well once completed. This is a huge advantage for the “seller” going forward as it leverages up the return on investment and lowers future capital requirements.

On the other side of the equation is the “buyer” who pays the upfront cash and absorbs the “promote.” Usually the buyer gets some PDP production which helps justify the initial cash payment, and steps into a development program which has been delineated (manageable risk) with a partner who has a proven track record. The return on the future development capital will not be as robust for the “buyer” as a result of the “promote,” but they have not been exposed to the initial risks or costs associated with the exploration aspect of the new play. This reduction in upfront costs and risk, combined with the prospect of rapidly climbing the learning curve and perhaps using the technology elsewhere, justifies absorbing the “promote.”

Based on the recent JV activity level there seems to be a continued appetite for this type deal and I anticipate more announcements in the future.

Update:  Another Eagle Ford JV anounced between Abraxas and Blue Stone.
 

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"We think there are a lot of opportunities out there. The shale plays take a lot of capital to drill all those leases…companies generally have to issue equity, structure additional debt, or sell their non-core conventional assets—which are what we want to buy."  -Alan Smith, Quantum Resources

In a recent article on OilandGasInvestor.com Leslie Haines interviews Alan Smith of Quantum Resources Management about the recent $900 million acquisition of Denbury assets.  It sounds like Quantum has a good investment plan targeting conventional assets (instead of the ultra-hot shale plays) in well established producing basins, and focusing their capital on enhancing existing production through infill drilling and waterfloods.  

Its refreshing to hear a company talking about doing business the "old school way"-- buy quality assets in mature basins and focus your efforts (and capital) on developing your assets with low risk drilling and flooding; not to mention the portfolio diversification effect of mixing oil and gas assets in different basins.   In the interview Mr. Smith refers to his business philosophy as "contrarian," but I would call it "good business."

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Apache's acquisition of Mariner is proof that much value exists in the deepwater Gulf of Mexico (GOM).  The deepwater (water depths greater than 1,000 feet) GOM is the playground of the "big boys".  The costs of exploration and development in the deep water GOM are immense.   This acquisition allows Apache to develop Mariners existing deepwater acreage position faster.   Although Mariners expertise in the GOM is important, Apache's brings to the table experience in offshore projects in Egypt, Nile Delta and Australia.  With resource plays driving most company's budgets these days, Apache steadily builds its asset base in the Gulf.  Look for more consolidation in the GOM and for Apache's 2.7 billion dollar flag to multiply.

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