Permian basin deal volume down, but not out

July 1, 2019

Despite a slowdown in Permian basin-focused merger and acquisition activity, hydrocarbon extraction from the region continues to be the driver of US onshore production. Expect to see deals endure as companies continue to seek ways to increase continuous acreage for larger-scale operations that allow for longer laterals and more recovery.

Permian production has increased every year from 2013-18—through one the worst downturns in the industry—and is expected to generate an average of 3.9 million b/d, roughly a third of total US oil production, according to the US Department of Energy.

“Indeed the consistent growth in production of crude oil and natural gas over the years, driven by highly productive wells, has encouraged companies to allocate their investment into owning more acreage in Permian basin via M&A deals and asset transactions,” said Andrew Folse, GlobalData upstream Americas analyst, who spoke to OGJ following the release of “Permian basin shale in the US, 2019—Oil and Gas Shale Market Analysis and Outlook to 2023,” which was co-researched by Adrian Lara, GlobalData senior analyst, upstream Americas.

Contiguous positions

As in other unconventional shale plays, Folse and Lara noted in the report, “Operators in the Permian basin continue to drill longer laterals beyond 9,000 ft and some reaching as much as 3 miles. The general objective remains to increase the productivity of the new producing wells in a higher proportion with respect to the cost increase associated with these more complex wells.”

Lara said, “Whenever possible, operators try to increase the surface of continuous acreage that would allow for larger-scale developments and longer well laterals. This is in fact one of the key drivers behind the recent offers made by Chevron [Corp.] and Occidental Petroleum [Corp.] to acquire Anadarko [Petroleum Corp.]’s acreage.”

The desire to expand existing acreage is expected to play a continued role in transactional activity. “In general, the M&A activity in the Permian is expected to continue over the coming years,” Folse told OGJ in May. “First, with smaller acreage swaps between operators that allow them to expand their existing acreage in a continuous surface to maximize their laterals lengths. Second, in the form of majors [and] large independents buying companies for their acreage also with the aim of maximizing the surface that could allow for the industrial-scale operations in which large companies have expertise and that can lead to higher economic margins due to the scale,” Folse said.

This was certainly the case in 2018 when Diamondback Energy Inc. and Concho Resources Inc. paid billions to acquire Permian peers and expand regional portfolios.

In late 2018, Midland-based Diamondback closed on a $9.32-billion stock transaction to acquire Energen Corp., Birmingham, Ala., including Energen’s net debt of $830 million. The deal increased Diamondback’s Tier 1 Permian basin acreage to 266,000 net acres from 170,000 net acres (pro forma for the company’s $1.25-billion deal to acquire interests and assets from Ajax Resources LLC that closed Oct. 31, 2018).

The combined company holds 390,000 net acres across the Midland and Delaware basins, where held by production assets will allow for multizone, multiwell pads, Diamondback said at the time.

According to Diamondback, expected primary synergies with net present value of $2 billion include a reduction in drilling, completion, and equipment costs of up to $200/lateral ft across more than 2,000 net operated locations in the Midland basin and an estimated general and administrative savings of $30-40 million/year. Secondary synergies with net present value of $1 billion include a reduction in drilling, completion, and equipment costs of up to $50/lateral ft across 1,500 net operated locations in the Delaware basin, the benefit of overlapping and adjacent acreage in Howard, Martin, and Ward counties, drop-down opportunities for Viper Energy Partners LP, and the combination of midstream assets across both basins.

A May 15 report from Jefferies analysts said Diamondback was “executing better than anticipated on acquisition synergies.” While the company had “expected to bring [Energen] Midland well costs in line with its own (~$800/lateral ft) from over $1,000/ft, it has already exceeded that target as it reduced Midland well cost guidance $740-780/ft (from $770-800/ft coming into the year),” the analysts said.

In late August 2018, Concho Resources Inc., also based in Midland, closed its deal to acquire RSP Permian Inc. (RSPP). The $9.5-billion stock transaction created one of the largest unconventional shale producers in the basin with a combined footprint of more than 640,000 net acres. Included in RSPP’s 92,000 net Permian acres was a 14,000-net acre block of Delaware acreage that Concho sold to Silver Hill in January 2016.

RSPP built a high-margin asset portfolio with large, contiguous positions in the core of the Permian, Concho Chairman and Chief Executive Officer Tim Leach said announcing the deal last year, and they did so “with a strategy of maximizing well performance and returns, which provides substantial running room for continuous development with large-scale projects.”

As part of its first quarter financials released Apr. 30, the company reiterated its strategy to advance large-scale development across its asset base. Inquiries by analysts about spending levels in a conference call to discuss the first quarter results prompted company assurances that it would “land within its full-year guidance and…pair back activity levels to get there if needed,” Seaport Global Energy analysts said in an investors brief May 2, noting Concho’s plan to drop its rig count to the low 20s this summer.

As another way to control its non-operating capital spending, Concho is looking to “monetize portions of its non-operated working interests on wells slated for near-term development,” the analysts said. “Management noted that there has been an increase in the number of companies looking to buy into these sorts of opportunities. On the acreage swap-trade front, management noted that more opportunities are becoming available—[Concho] did 15 swaps in fiscal year 2018 and did 5 alone in first-quarter 2019. Management executed on two large swaps last year and currently sees the opportunity for two similar trade opportunities,” the analysts said.

Turning back to large-scale development, the most recent—and perhaps, most dramatic—example is Oxy’s targeting of Anadarko for its Permian assets—outbidding Chevron in the process. For Oxy, the deal creates a company with a “highly complementary asset portfolio” positioned to deliver on the upside of Permian shale development.

For Chevron, which already holds 2.2 million net acres in the Permian from which it produced 159,000 net b/d (Chevron share) of crude oil, 501 MMcfd of natural gas, and 66,000 b/d of natural gas liquids in 2018, “Winning in any environment doesn’t mean winning at any cost,” said Michael Wirth, Chevron chairman and chief executive officer in early May. “Cost and capital discipline always matter, and we will not dilute our returns or erode value for our shareholders for the sake of doing a deal,” he said upon announcing that the company would not make a counterproposal to acquire Anadarko following Anadarko’s “superior proposal” determination of Oxy’s revised bid.

Speaking in general terms, Joe Dunleavy, PwC, EU&M deals leader, told OGJ via e-mail in early June that energy companies are not going to chase deals at any price. “Limited access to capital, uncertainty about commodity prices, and shareholder demands for value over revenue growth will reign in M&A. However, distressed sales and strategic rebalancing of portfolios are likely to occur in the current environment, giving a boost to M&A activity,” he said.

Deal volume, price

Deal pricing will continue to be a factor in Permian transactions of all sizes.

“CEOs whose operations currently are generating sufficient cash flows may not be incentivized enough to sell at today’s buyer valuations. They may be more keen to keep operating their business and retain the ‘call-option’ of higher commodity prices in the future,” Dunleavy said. “However, the constrained access to capital, and investors looking for return, will force certain producers to sell assets and seek alternative financing solutions to fund operations and drilling programs. In our view, forces driving a reduction in the bid-ask spread and an increase in M&A include increased investor activism and sustained lower commodity prices,” Dunleavy said.

In short, companies with Permian operations must decide if they have sufficient and economical scale and financing to remain, Dunleavy said. Those that do will look to increase shareholder value through operational efficiencies and M&A, he said, and those that don’t will divest those assets, “redeploying this new capital to other basins where they have the scale and infrastructure to generate positive cash flow.”

He said, “Certainly, there are companies fortunate enough to have the balance sheet and financing to use M&A to acquire the scale they need to be successful in the Permian, including through a single transaction.”

PwC analysis showed the volume and value of deals in this year’s first quarter substantially lower than those in the same period a year ago—5 deals worth $3.2 billion in first-quarter 2019 vs. 15 deals worth $12.8 billion in first-quarter 2018. With 6 deals worth $2.9 billion in fourth-quarter 2018, volume is down in this year’s first quarter by 1 deal with value slightly up, Dunleavy said.

Cimarex Energy completed the largest deal of the quarter with its $1.6 billion buy of Resolute Energy, GlobalData’s Folse said. With it, Cimarex added 35,000 boe/d (45% oil), and more than 21,100 acres in Reeves County.

Smaller deals included Callon Petroleum selling noncore Midland basin assets to Sequitur Permian LLC. The $245 million in net cash proceeds are not inclusive of potential contingent consideration payments of up to $60 million based on West Texas Intermediate average annual pricing over 3 years. In the deal, Sequitur gains 9,850 net acres (66% working interest), and an average of 4,000 boe/d (52% oil).

Deals in the billion or multimillion-dollar range garner most attention but deals of all sizes and all forms are being negotiated in the Permian. An estimated 72 Permian basin-associated deals were announced from early January to early May of this year, according to GlobalData research. Of those, 17 closed or were expected to close by July. Most of these deals targeted Permian interests specifically, while a few transactions included Permian interests as part of the broader deal.

Large or small, expect movement in the basin to continue.

“Over the last couple of years, we have seen activity in the Permian exceed the other basins in the US. During 2019, we expect other basins will become active, and even may exceed the Permian’s deal volume or value in a given quarter,” PwC’s Dunleavy said. “However, at the end of 2019, we expect the Permian to retain its leading M&A position.”