AN INTERVIEW WITH John B. Walker, EnerVest CEO - EnerVest’s strategy: Buy right, operate efficiently, and plan for divestiture

EDITOR’S NOTE: EnerVest Management Partners, Ltd. manages oil and gas assets for institutional investors and is active in both acquisitions and divestitures. Since its founding in 1992, the company has acquired more than $2 billion in upstream oil and gas assets in the US. EnerVest operates more than 10,000 wells in 11 states. CEO John B. Walker recently took time out of his schedule to talk with OGFJ.

OIL & GAS FINANCIAL JOURNAL: How was your company founded and how did it evolve?

JOHN B. WALKER: I founded EnerVest in 1992 with the Jones family of Albany, Texas. It took us two years of hard work chasing deals to do our first transaction with GE Capital. We were their first general partner in the oil and gas sector, and they were our first partner as well. In total we did 6 transactions with GE totaling $350 million.

In 1998, we began raising multi-institution funds, starting with $100 million, followed by $172 million and $550 million, bringing us to Fund XI, which raised $1 billion and is expected to close in late May. We manage approximately $2 billion in oil and gas assets, operate more than 10,000 wells in 11 states, will drill more than 300 wells this year, and hope to do in excess of $1 billion in acquisitions this year.

OGFJ: How is your company organized - that is, don’t you actually have two different operating groups and manage several partnerships, including a publicly traded master limited partnership (MLP)?

WALKER: Our company’s two operating groups are the Eastern Division, based in Charleston, West Virginia, which oversees our Michigan and Appalachian assets, and our Western Division, based in Houston, which oversees the remaining assets. Four institutional partnerships, and the new publicly traded master limited partnership, EV Energy Partners (EVEP), collectively are managed by EnerVest.

OGFJ: How much has the company invested since its inception?

WALKER: More than $2 billion.

OGFJ: How have you been able to buy all of these properties?

WALKER: To me, the most important acquisition tool is relationships. Everyone who works at EnerVest is a deal-finder, and we talk about that quite a bit. Buyers and sellers who know each other professionally and socially will be more willing to close a deal than if no relationship exists. I encourage all of our employees to be active in their respective professional societies and our oil and gas associations. These are great places to meet the people who will sell our next deal to us.

We have had several deals come our way simply because a prior relationship was in place, and the majority of our acquisitions are negotiated transactions rather than broad auction processes.

OGFJ: In all, how many people does EnerVest employ, and where are your offices?

WALKER: We have around 360 employees and growing. Our headquarters office is here in Houston, and we have a division office in Charleston, West Virginia. We also maintain field offices in 8 states.

OGFJ: Over the course of the past 15 years, the oil and gas industry has seen a number of up and down cycles, yet EnerVest’s institutional partnerships have generated rates of return in excess of 32% on exited projects. What is the secret to your success - how have you been able to achieve this rate of return?

WALKER: The first key to success is disciplined purchases. Overpaying for assets kills returns. Over the years, we had second and third chances to buy properties where the initial buyer paid too much and failed as an asset manager. The second step is operating focus and intensity. There is no magic formula to operations - it is 100 different small improvements that add up to higher production and lower costs. For our institutional partnerships, the last step is to always be a portfolio manager of the assets and unemotionally sell them when the time is right.

OGFJ: How would you describe your investment strategy?

WALKER: We like long-lived reserves, both oil and gas. As I mentioned earlier, buy right, operate efficiently, and for acquisitions in our institutional partnerships, plan for the divestiture from the beginning.

Our goals are a little different from most oil and gas companies. Annual growth in reserves and production is not an effective way to measure our results. What we focus on is rate of return to our investors, so our acquisition - or investment ­- strategy has to match that goal.

OGFJ: What are some of the biggest deals EnerVest has done, and can you provide a few details?

WALKER: The biggest deal we have done in terms of dollar value was our acquisition of Belden and Blake in 2005. We had wanted those assets for a long time, but we were forced to stay patient as control of the company changed more than once since we became interested. But that gets back to maintaining discipline in acquisitions. If the deal isn’t right, you have to be willing to walk away no matter how much you like the assets. Also, in our roughly $1 billion of acquisitions in 2005, 8 of the 10 deals were negotiated, highlighting 2 things: our relationships and our ability to solve complex problems in purchases.

In terms of realized return in our institutional partnership business, one of our biggest deals was an acquisition we made in the Permian basin in 2003. The rate of return to our investors was more than 100%. Some of that performance was due to the increase in oil prices. But, through drilling and workovers, we doubled production and more than tripled reserves in the field.

OGFJ: Can you explain your due diligence process and how long it typically takes?

WALKER: Our due diligence process is comprised of what we have learned in the last 15 years of making acquisitions. The process takes from 30 to 90 days based on the size, complexity and recordation quality of the deal. Our team is highly experienced and focused on closing the transaction, not killing the deal.

OGFJ: You have mentioned EVEP a few times. Why did you create it?

WALKER: The ideal portfolio for our institutional business is 50% producing, 50% upside. That means a lot of high-rate-of-return drilling and workovers. Historically, when a substantial amount of that work was done, we sold the properties. We liked many of these properties and wanted to keep them for basin dominance. The MLP’s ideal portfolio is 80% to 90% proved producing reserves and a measured plan for the pace of drilling proved undeveloped reserves. EVEP is a perfect buyer for our institutional assets, once relatively developed.

OGFJ: Has the performance of EVEP met your expectations?

WALKER: We had many expectations, and the answer to date is overwhelmingly “yes.” We communicated to Wall Street our defined and conservative views about how a MLP should be set up and run for success. In 7 months, through accretive acquisitions, we increased production by more than 3 times and reserves by about the same amount. EVEP has been the top unit price performer among its peers. At the same time, our asset sales from our institutional partnerships to EVEP for cash and units have, at a minimum, met the expectations of our institutional investors.

OGFJ: Percentage-wise, how much of your assets would be considered low-risk development-type properties versus higher-risk plays?

WALKER: Virtually all of our assets would be considered lower-risk development-type properties. We don’t chase the latest play that is the current buzz-word at investor conferences. While we’re involved in 2 shale plays, tight gas in East Texas and coal-bed methane development, none is considered to be “the” play, such as the Barnett, Fayetteville, or Woodford shale. Some companies have done very well in those plays. At the same time, I think others have wasted a lot of money in those same plays.

OGFJ: Where do you see future growth opportunities?

WALKER: Market seers foresee a $30 to $40 billion US A&D market this year. We already have focused on proposed asset sales that would either enhance our positions in our existing basins or provide us with a major presence in new basins. Our horizontal drilling is going well to-date in Ellis County, Oklahoma, and what we have learned there is applicable to many of our existing areas.

OGFJ: What is the most exciting project you are currently working on?

WALKER: It is the Ellis County project in one of our institutional funds where we are drilling 3,500-foot laterals in the Cleveland sands. The results so far are delivering returns above 100% and reserves per well that are above expectations.

OGFJ: To what extent does the cyclical nature of the oil and gas industry - i.e., price fluctuations - affect your business? Do profits soar when prices are up and decline when they go down?

WALKER: Everyone is smart when prices go up and dumb when prices decline. No one can forecast oil or gas prices, and therefore we hedge them for periods of 2 to 4 years.

OGFJ: How much of your production is hedged, and how do you determine how much to hedge and when to do it?

WALKER: Hedging is part of risk management, and I emphasize management. It is not a one-time decision. Hedging should be layered in to protect margins, assure rates of return and, in the case of EVEP, assure quarterly distributions. We try to hedge more and longer in periods of ebullience, and simply protect acquisition economics when prices are falling. We use swaps, wide collars, and narrow collars. We find that puts, in most cases, are too expensive and that they hurt rates of return.

OGFJ: What is the single biggest constraint on EnerVest’s growth and profitability?

WALKER: People. Followed by both the cost and availability of services. Costs seemed to have at least flattened, but we don’t have a quick fix for the personnel shortage in our industry. We are fortunate at EnerVest to have great employees, and we have been able to add to our staff in the past year. We, like all of our competitors, continue to search for more engineers, geologists, and landmen. We doubled the size of our company from 2005 to today, and with our $1 billion Fund XI and EVEP, we probably will double in size again in the next 2 to 3 years. So we need people. If you know of any, please let them know that EnerVest was voted “Best Place to Work” by the Houston Business Journal 3 of the last 6 years, and ask them call me.

OGFJ: What is the single biggest opportunity you can foresee, and how do you plan to take advantage of it?

WALKER: EVEP. We conceived of the complementary nature of an MLP for our institutional partnerships 5 years ago, long before investment bankers would support us. The institutional partnerships are a great complement to EVEP and provide an additional avenue for its growth. EVEP is a great buyer of institutional assets that are 80% to 90% developed.

OGFJ: Finally, what can you tell us about your plans and goals for the future?

WALKER: We are spending a lot of effort and money on increasing the geological input into our buying and operating decisions. Advanced technology also is being used more. The ability to do large acquisitions ($1 billion and larger) also puts us into a different competitive situation. In our institutional partnerships we continue to look at Canada and a few select countries as possible areas in which to invest in the future. Like our 5-year time frame from conception to execution on the creation of EVEP, we will be very methodical about investments outside the United States.

Thank you for taking the time to talk with us.

Don Stowers, Editor, OGFJ

Photos by Hugh Hargrave