A. D. Koen
Gulf Coast News Editor
Robin Buckner Price
Staff Writer
Major U.S. oil and gas companies' accelerated rationalization of U.S. upstream assets in recent years has left a glut of available producing leases in a capital starved market.
The expanding divestment of such properties in the U.S. stems largely from a shift in upstream emphasis by majors to areas outside the U.S. As more of their exploration and development capital flees the U.S., majors are cutting the scope of their remaining U.S. operations, selling nonstrategic assets piecemeal and in sizable chunks.
Continuing a process that began in earnest for some companies before the 1986 oil price collapse, companies are assessing individual leases and wells for their strategic fit.
That process has resulted in a change in direction for majors, which until 1989 had been net buyers of production, and has put up for potential sale as much as $10 billion worth of U.S. producing leases.
However, the number of buyers are few, and the pace of sales is slow. Lack of capital and oil and gas price uncertainty are fueling a standoff between buyers and sellers, although innovative agreements and financing have pushed through some large transactions. With all the properties on the market and the current slowdown in activity, some officials expect a surge in deals before yearend. Even so, the overhang of available production on the market isn't expected to lead to a freefall of asset prices and instead is expected to correct itself in time, industry officials say.
COST OF RESERVES
A survey by John S. Herold, Greenwich, Conn., shows it is increasingly more cost effective to buy reserves than drill for them in the U.S.
Herold notes the 1991 cost of replacing U.S. reserves for the 186 public companies it surveyed rose nearly $1/bbl of oil equivalent (BOE) to $6/BOE. Excluding reserve acquisitions, the cost of additions via drilling jumped to $6.88/BOE from $5.16/BOE.
That compares with U.S. costs of acquiring proved reserves that averaged $3.62/BOE in 1991 and $4.33/BOE in 1990. Herold estimates acquired production accounted for 27% of the group's total U.S. reserves replacement in 1991.
Given that widening differential, Herold expects acquisitions to become a more important means of replacing reserves for companies committed to expanding their U.S. base.
"The exodus of majors from the U.S. and the resulting $10 billion overhang of properties on the market, coupled with diminishing exploration profits, will only enhance acquisition economics in the near term," Herold said.
CHANGE OF STRATEGY
Since 1989, net combined property divestments have exceeded acquisitions among a group of 15 large companies tracked by Randall & Dewey Inc. (R&D), Houston.
R&D Partner Kenneth W. Dewey said the rush to sell U.S. oil and gas leases in part has emerged because of a strategy reversal by a few large U.S. oil companies dominating acquisition and divestment (A&D) action.
In the early and mid-1980s, the 15 companies tracked by R&D-today's big sellers-accounted for most U.S. oil and gas production acquisitions, Dewey said. R&D considers 1988 the turning point for companies in the group.
"From 1983 to 1988, this group was a significant net purchaser of U.S. producing assets," Dewey said. "Starting in 1989...they became net sellers."
That trend has continued. Dewey said R&D group combined net divestments were about $200 million in 1989, about $1 billion in 1990, and more than $2 billion in 1991.
For independent producers, the divestment strategies mean some good leases outside major company core areas are for sale. As a result, Dewey said U.S. exploration and production activity likely will become dominated by niche players that make the most of opportunities on leases that don't fit the majors' strengths or are outside their core operating areas.
"As an overall market change, we're seeing properties move from being owned by a small number of majors that act similarly in many ways to independents who have defined niches where they can explore, develop, and produce profitably," Dewey said. "And I think we're going to see a lot of small independents become midsized and large independents."
Leading Herold's list of available deals is Chevron Corp. offering for sale U.S. oil and gas reserves totaling 300-400 million BOE worth $1.5-2.5 billion. Shell Oil Co. is second on Herold's list with about 200 million BOE of reserves valued at $1-1.2 billion, followed by ARCO with 100-150 million BOE worth $500-800 million, Exxon Corp. with about 100 million BOE worth $500-600 million, and Phillips Petroleum Co. with 75-85 million BOE worth about $350 million.
Herold estimates 1.9-2.1 billion BOE of oil and gas reserves worth $9.8-11.9 billion are for sale in the U.S. and Canada combined.
Despite the large volume and value of U.S. oil and gas properties for sale, Herold said the pace of sales has been less than spectacular.
"At the first half 1992 pace of transactions, it may take up to 5 years for all the properties to sell," Herold said.
VALUE OF DEALS
R&D's Dewey said U.S. oil and gas properties worth about $10 billion would be for sale if markets allowed. But that estimate includes sales companies want to make but aren't proceeding because of poor market conditions.
For the 15 companies it tracks, R&D estimates a value of $3 billion for U.S. reserves for sale.
John Spence, general manager of worldwide acquisitions and divestments for Amoco Corp., is skeptical about the accuracy of reports of large numbers of U.S. oil and gas properties on the market and whether they are realistically priced or are likely to find buyers.
"We don't see a lot of money flowing into the industry," he said. "In the first half of 1992, in spite of all the hype about what's going on, the number of deals closed is way down from last year."
Spence estimates producible U.S. leases sold for about $13 billion in 1991, with many deals including stock trades or mergers. Although a lot of companies still are trying to sell production, not many are buying.
"Totals can look high, but when you start looking at cash that's changing hands-as opposed to mergers or deals that got started some time ago and only now are coming to conclusion-the market may not be as great as these people say it is," Spence said. "I'd be surprised to see much more than $2-3 billion get closed in this quarter."
Meantime, production auctioneer EBCO U.S.A. Inc., Oklahoma City, saw 1991 sales increase 80% to $45.5 million from the prior year. The company expects a 200% increase in sales in 1992. Paul Smart, EBCO president, said data gathered from 345 registers bidders at a recent auction showed more than $255 million in capital available to buy a little less than $6 million worth of producing leases. Smart said the company this year probably will sell fewer properties than the 12,000 leases sold last year, but the average value will be much greater.
"We are handling a lot more exclusive sales," he said. "You might have only 100 properties in a sale, but they might bring anywhere from $2.5 million and $5 million. That compares with a sale that had 1,250 properties that brought about $2.1 million. So the average value per property is increasing this year."
CHEVRON DIVESTMENTS
Chevron has been a net seller of producing leases in the U.S. as part of a company-wide restructuring since 1984, when it changed its name from Standard Oil Co. of California and acquired Gulf Corp.
Bill Gavan, manager of property enhancement for Chevron U.S.A. Inc., said the divestment program has included selling small and/or marginal properties and fine tuning operations in strategic basins. The goal has been to sharpen the focus on Chevron's U.S. operations, not withdraw from the country.
Gavan said major Chevron divestments would have occurred in any case because of the Gulf deal and the 1988 acquisition of Tenneco Inc.'s leases in the Gulf of Mexico.
"However, also as part of our overall strategy, there has been a tendency to shift investment emphasis from U.S. production to foreign," he said. "That is just a recognition of the maturity of opportunities in the U.S. and the lack of freedom to explore important areas offshore and in Alaska."
At yearend 1991 Chevron was operating wells in about 950 U.S. oil and gas fields. Chevron wants to sell operations in about 550 of those fields, reducing its daily U.S. production by about 20%. After unwanted U.S. leases are divested-possibly by yearend 1993-Chevron expects to retain properties that accounted for more than 85% of its U.S. reserves prior to divestment. The company also expects to have reduced its U.S. upstream workforce by about 28% when its restructuring is complete. Gavan said after the restructuring, Chevron core areas of operations in the U.S. will be the Gulf of Mexico, Permian basin, Rocky Mountains, California, and Alaska. The company decided many of its other leases could be best managed by an independent operator rather than a major.
"We felt getting the value out of the properties for sale would allow us to go through this restructuring and refocusing," he said. "We're not exiting from any of our major areas, but it is a major trimming of the portfolio."
By sometime next year, Chevron U.S. A&D activity will return to closer balance, Gavan said.
ARCO'S PROGRAM
ARCO was another early entrant in a focused campaign of divestment.
Tom Holland, ARCO's manager of land and external operations, said, "It was in 1985 that we began thinking about divesting U.S. production in a big way. In 1986 we made our first really big transaction. That was the year we sold 665 fields to Hondo Oil & Gas Co. and Amoco.
"ARCO, perhaps a little ahead of the industry, saw the collapse in oil prices and decided at that point to take a hard look at our properties and divest those that we felt were nonstrategic. That was the year ARCO underwent its first major restructuring, where we took writedowns on properties and reduced our workforce."
Including the major sale in 1986, ARCO has sold about $700 million worth of leases in the last 7 years.
But Holland noted, "We are committed to staying in the Lower 48, and we are doing it in such a way that we can focus on key assets."
ARCO sold $300 million worth of leases in 1986, $200 million in 1987, $10 million in 1988, $21 million in 1989, $42 million in 1990, and $21 million in 1991. It plans to sell $100 million in 1992.
Holland said the main reasons for the jump in divestitures this year are greater scrutiny of its small and medium size fields and a jump in market interest in ARCO leases.
"We took a little more critical look at the value of these properties to us. We also took a very critical look at the cost structure of the properties and what a major can bring to these properties."
Holland said most of the leases it has on the block now are in the Permian basin, mainly because there are many small properties there. ARCO has production for sale in California as well. The company has sold most of its noncore assets in the Midcontinent and Rocky Mountain regions.
AMOCO'S PLAN
Spence said Amoco's divestment program also is driven by efforts to get a better focus on operations.
Judgments about whether majors are selling U.S. leases to raise funds for non-U.S. investment or just because it makes sense in today's oil and gas markets require company by company study, he said, adding that he is unaware of any majors aggressively buying U.S. production.
Since it sold assets grouped in MW Production Co. to Apache Corp. for $454 million the past year, Amoco has not been particularly active in A&D markets, Spence said.
"For us the MW deal was a focusing, a streamlining. It was something that made sense from every business perspective," Spence said. "I see other majors doing the same kinds of things we tried with MW. Get property counts down, improve company focus, and get your arms around the things you do and do well."
More than a year after the sale to Apache, Spence said, Amoco still is putting significant effort into the usual sort of cleanup following acquisitions or divestments. Amoco's focus this year has shifted to trading properties with other majors to continue consolidating its position and thus lower costs in key areas.
PACKAGING PROPERTIES
Spence said deciding how to package leases for sale is a fundamental question in trying to streamline operations.
"There's always a struggle on whether to sell properties in $500 million, $50 million, or $5 million packages," he said.
In the case of MW, Amoco hoped either to set up a separate company or put together a complementary basket of assets that would attract a good price. In that deal, Amoco sold relatively rapidly declining leases accounting for about 8% of its U.S. production and 4% of its U.S. reserves.
Gavan said Chevron typically groups leases into packages small enough to attract regional buyers.
"In the past, we allowed buyers to bid on portions of packages, so we had the flexibility to attract large and small buyers," he said. "Large buyers could bid on whole packages, smaller buyers could pick and choose pieces, and we tried to optimize the sales when we decided which bids to accept."
Chevron still is following that strategy in some areas. However, because of its decision to quickly divest a large number of leases, Chevron is considering creating much larger packages of what it wants to sell, namely properties in the Permian basin, Midcontinent region, on the Gulf Coast, and in the Gulf of Mexico.
BUYING A STRATEGIC FIT
The focus on core assets led Kerr-McGee Corp. in 1991 to purchase about 11 million BOE of Wyoming reserves from Sonat Exploration Co. for $66 million, a move atypical of a major in this environment.
Luke Corbett, group vice-president, said, "Obviously when you make an acquisition you have a base idea that you can bring value to those properties.
"In Sonat, when we looked at that set of properties, we had very good results at North Buck Draw field with miscible gas floods, we were working Sand Dunes field, we had quite a bit of expertise in the Powder River basin, and we had a lot of ideas for exploration and exploitation. It just was a good strategic fit for us."
Corbett said in 1991 the company spent about $100 million on acquisitions, including the Sonat deal, and had another $220-230 million available.
"But again, these are domestic opportunities and you have to ask yourself, what part of this domestic market do you want? Where is this opportunity? Can you add value? And is it a good business decision considering how we have to do business in the U.S.? There is a shift one has to go through mentally."
INDEPENDENT BUYERS
Among independent producers, Devon Energy Corp., Oklahoma City, has decided to focus strictly on U.S. operations for now and has completed its $126.6 million acquisition of the U.S. leases of Hondo, Roswell, N.M., in late July (OGJ, July 6, p. 36).
Devon has added 40-45 persons as a result of the acquisition, a 30% increase in staff, representing about $2 million/year in added salaries. About 50% of staff added were former Hondo employees.
J. Michael Lacey, Devon vice-president of operations and exploration, said all but 12-15% of the Hondo acquisition was a strategic fit with Devon's operations. "We have a few properties that are not a comfortable fit for us, and we plan to market those."
H. Alan Turner, Devon vice-president of corporate development, noted, "One of the things that creates opportunity for the growing independent is the strong trend toward becoming a dominant player in a particular basin.
"The last thing we want is interests in thousands of wells in 15 states, and from a marketing perspective no single well or group of wells you can put together can become even remotely significant to a purchaser. That will no longer work."
"In the acquisitions we look at, marketing is always a key factor for oil and gas," said Darryl G. Smette, Devon vice-president of marketing and administrative planning. "We look at the pipelines that are in the area and how well we work with those pipelines. Are they markets we perceive as being good markets in the future, and what is the competition going to be for those markets? If we find the markets aren't as good as we would like, that would kill a deal for us."
Future Devon acquisitions are limited by opportunity, not by Devon's means, Turner said. "We have a balance sheet and cash flow remaining that are capable of handling another acquisition. We came out of the Hondo acquisition stronger than when we started," he said.
Turner noted the situation today is much like the onshore Gulf Coast area in the early 1970s. "At that time, majors were leaving onshore exploration and development to explore the Gulf of Mexico, and companies like Louisiana Land & Exploration Co. and Freeport McMoRan filled the void left by majors. We believe the same thing could be happening now in that a few small companies can move in and fill the void left today by majors going overseas. Those few could grow very quickly."
Elsewhere, Vintage Petroleum Inc., Tulsa, spent about $21 million in 1991 buying about 8.1 million BOE of reserves at about $2.60/BOE.
So far in 1992 Vintage has acquired another 7.4 million BOE for $13.7 million, slightly less than $2/BOE, with about half of those reserves in heavy oil leases in California.
Vintage Pres. Charles C. Stephenson Jr. said, "The game plan for the company during 1992-93 is to double our reserve base to 80 million BOE. To do that we are going to have to either make a series of smaller acquisitions or a fairly large acquisition. We'll take them any way we can get them."
Stephenson said Vintage looks at about 30 deals/month and screens those down to one or two that have significant upside potential and fit its operational plan.
Some independents are turning to non-U.S. sources for capital.
For example, Petro-Hunt Corp., Dallas, which wants to spend more than $100 million for acquisitions in 1992, used a group of banks mainly outside the U.S. for a sizable purchase of Chevron properties, its fifth acquisition this year (OGJ, July 20, p. 38).
PRICE UNCERTAINTY
R&D's Dewey said estimates of future oil and gas prices are top considerations in structuring a producing lease purchase.
Aggravating that uncertainty is the issue of environmental liability, which becomes more important each year in efforts to close trades.
"In a volatile price period like we've been in for the past 1 1/2 years, getting buyer and seller to agree on price is more difficult because of differing expectations," he said. "Sellers want to sell on the most recent good news, and buyers want to buy on the most recent bad news. Creative sale provisions will be necessary to get some deals done."
Dewey cited the Apache-Amoco deal as a good example of a deal with a creative structure that bridges the gap between buyer and seller expectations without compromising their bargaining positions. After going through price shocks resulting from war in the Middle East, for a while no one was sure where prices were heading, Amoco's Spence said. "Apache was reluctant to buy at the upper boundary of our price expectations, and we weren't prepared to sell in the lower range of theirs."
William Johnson, president and chief operating officer of Apache, said the deal finally was closed because Amoco had engineered a bundle of assets that made evaluation somewhat easier and the two companies were able to negotiate innovative terms.
Johnson attributed closing the deal to four main elements:
- $515 million in bank debt.
- Two million shares of Apache stock, about 4%, which Amoco still holds.
- A net profit agreement on Amoco's large interest in New Mexico Federal Unit (NMFU).
- A price sharing mechanism that allows the two companies to close the gap between buyer and seller outlooks for oil and gas prices.
Johnson said Amoco and Apache agreed on the production payment after they could not agree on a value for the NMFU properties. And Spence said Amoco allowed Apache some downside price protection in return for being allowed to participate in possible upside prices.
"That moved the banks' comfort index up near term and made them a lot more comfortable that, even in case of disaster, Apache through this price floor mechanism would be in a position to service its debt," Spence said.
Because of the innovative provision, as of last July 1 Amoco owed Apache crude price support payments of about $2-3 million.
"It's not a huge amount of money, Spence said, "but it could have been significantly more."
LACK OF CAPITAL
Dewey said there is no lack of opportunity to buy U.S. oil and gas leases because of the large number of potential sellers.
"Lots of companies want to buy the assets, but their sources of capital are extremely limited," he said.
As a result, many sellers are considering deal structures that help buyers overcome their lack of money.
"It's not something sellers want to do, it's something they are being forced to do to complete their sales programs," Dewey said.
Chevron's Gavan said buyers in smaller transactions appear to have better access to funding than buyers trying to set up larger deals.
"They seem to be able to do deals very much like the ones we've done in the past and at similar levels of value," he said. "So to the extent a major has the time and capability to break properties into smaller packages, there seems to be a small number of players willing to bid the kinds of numbers that are attractive."
However, difficulty is apparent in present A&D markets for deals involving mergers or larger packages of properties, Gavan said. Assets grouped into larger packages must be marketed differently.
"However, there seem to be buyers out there that either have balance sheets that support larger acquisition or banks or partners that are willing to help them bring in deals," Gavan said.
Spence noted there are some limitations on seller financing, and price sharing or other hedging mechanisms likely will be needed to help close many sales. He cited companies with large asset bases that might receive added value from selling a noncore property with upside economic potential by retaining limited equity participation after a lower cost operator takes over wells in the deal.
"Companies can structure partnerships around properties in specific geographic areas and benefit from the focus, drive, and low cost structure of independents," he said. "In the net profit agreement we structured in New Mexico, by doing a lot of work Apache can get us out very quickly. Then all the benefit will accrue to them."
Devon financed its Hondo acquisition via common stock offering that raised a net $86.6 million and borrowing $40 million via expanded credit lines.
Turner said financing can definitely be a deal breaker.
"Quite frankly, if a property looks great from the marketing standpoint and wonderful from an operating standpoint, but the method of financing is going to cause dilution to the existing shareholders, that won't work.
"You can make that mistake once, you might get away with it a second time, but you won't get away with it a third time. Once you've denied yourself access to the capital markets, how are you going to grow? You are left with internally generated capital, and the last 4 or 5 years that has been pretty difficult."
EFFECT OF OVERHANG
Despite the many producing leases for sale in the U.S., Johnson said, independent operators interested in acquisitions should take an active stance.
"At least let the sellers know you're there and interested." he said.
He contends maintaining relationships is important in learning about available properties. And major companies serious about selling large packages of properties must realize that many interested buyers don't have enough financial liquidity to simply ask for offers.
"Everyone of these deals will have to be tailored to accommodate buyer and seller," he said. "People have to sit down and talk to each other."
Gavan said the apparent overhang of available properties likely will be self-correcting. Companies that can't get fair value likely will try different marketing plans rather than adopt fire sale mentalities.
"Deals will either stretch out over time because people can't put them together or they'll adopt different ways to handle the transactions," he said. "Most majors are not in such financial shape that they would be willing to go into a fire sale mode, which would then get into a price freefall.
"Truly, if everybody tried to dump all the properties rumored to be on the market and were willing to sell at any price, we would end up with a significant erosion of prices," Gavan said. "I don't think that will occur."
But there will remain the question of what this huge transfer of production will mean for the U.S. over the long term as companies focus more on replacing reserves through acquisition vs. drilling in the U.S. or simply expand their reserves base worldwide at the expense of that in the U.S.
"We aren't drilling enough wells in this country in terms of keeping up with reserve additions," Kerr-McGee's Corbett said. "And I'm afraid when it's time to turn on the tap, if our growth in gas (demand) continues...we are going to find the producibility is not necessarily there.
"We have lost half of our employee base, our infrastructure will continue to move out, the service sector has been decimated. It's going to be difficult to turn the button to on and watch this machine move again. It's just not going to happen...We drill more dry holes in Washington that any other place I know of."
Copyright 1992 Oil & Gas Journal. All Rights Reserved.