What's With All These JVs?
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.
