A&D market expected to heat up in 2005

In their quest for hydrocarbons, different oil and gas companies have different needs, so some will always be on the lookout for properties that fit their growth strategy, while others may be looking to monetize their assets.

With many of the large independent and major integrated oil and gas companies facing stagnant reserve replacement or falling reserves, industry observers are predicting that asset acquisition and divestiture activity will intensify in 2005.

In addition to the reserves issue, another key reason the buying and selling of oil and gas properties continues to be a subject of intense interest is that many exploration and production companies have determined that exploratory drilling - both onshore and offshore - tends to be more costly and holds greater risks than developing proved reserves. By that reasoning, acquiring producing assets or undeveloped reserves can be a less expensive, less risky option in the minds of many oil and gas executives.

Despite the decline in exploration, US drilling activity remained just below a 19-year high as this issue of Oil & Gas Financial Journal went to press. Baker Hughes Inc. reported that there were 1,282 rotary rigs working the week ending March 11. Of these, 93 rigs were working in US ocean waters, including 89 in the Gulf of Mexico. Land drilling accounted for 1,161 rigs, and 28 rigs were operating in inland waters. Canada’s rig count was 441.

While the high rig count shows a healthy appetite for drilling, the relatively low level of exploratory activity would seem to indicate a predisposition to minimizing financial risk.

Historically, during periods of low profitability in the petroleum industry, energy companies begin a process of selective divestiture of non-core or less-profitable assets. Conversely, during periods of high profit taking, oil and gas executives are keen on acquiring assets - either whole companies or specific properties - that they expect will enable them to increase both revenues and profit margins.

Buying marketing expertise

Because of current high commodity prices, especially for crude oil, deal-making is on the ascendancy again. This represents a boon to companies such as Madison Energy Advisors that serve as divestment advisors to energy companies seeking to sell their producing property or properties for maximum value.

Many risk-adverse companies see taking the A&D route as simply carrying out their fiduciary responsibility to company stakeholders, says Tim Sullivant, chief operating officer of Madison Energy Advisors, a comprehensive transaction advisory service to the oil and gas industry since 1994. Houston-based Madison is a business unit of PennWell Corp., which publishes Oil & Gas Financial Journal.

Services such as that provided by Madison are needed by the seller to obtain maximum market value for them, says Sullivant, who served as vice president of business development for Griffis & Associates, another Houston-based advisory service, before joining Madison in 2004. Prior to that, he held A&D management roles for Sequoyah Resources, Bellwether Exploration, Scana Petroleum, and Torch Energy Advisors.

“Significant divestment strategies combined with an immense asset appetite from new regional players have made this an open and active market that drives up the rate of return,” says Sullivant. “The name of the game is maximizing your A&D performance, regardless of which end of the deal you’re on.”

In addition to Madison, other key players in the A&D space include Weisser Johnson; Petroleum Place; Albrecht & Associates; and Randall & Dewey, acquired by Jefferies Group Inc. in February. Many of these A&D specialists offer turnkey services that combine reservoir geology and engineering services along with E&P data management and other consulting activities that facilitate the exchange of oil and gas assets.

Operating synergies sought

In February, Houston-based El Paso Corp. agreed to acquire two major gas-producing properties in East and South Texas totaling $211 million. The properties add about 124 bcfe of proved reserves and 29 MMcf/d of average net production, the company said, adding that about 59 percent of the reserves are undeveloped.

An El Paso spokesman said, “Both acquisitions offer significant future drilling opportunities and fit well with El Paso’s existing operations.”

In both cases, the newly acquired properties are directly adjacent to fields currently operated by El Paso and are a good fit with the company’s overall strategy and existing infrastructure.

The company spokesman added that these were “low-risk” acquisitions that will enable El Paso to achieve operating synergies as the new assets are integrated into company operations, which was a prime reason for the acquisition.

Similarly, XTO Energy Inc. chose to purchase privately held Antero Resources Corp., a prominent Barnett Shale producer, for cash and equity consideration valued at about $685 million. The acquisition significantly increases XTO’s potential acreage in Parker and Johnson counties of Texas, which have been among the prime Barnett Shale producing areas.

XTO engineers estimate proved reserves to be 440 bcfe of natural gas, 41 percent of which are proved developed. Existing production from the properties totals 60 MMcf/d, which will enable the company to increase its production growth target in 2005 from 18-20 percent to 21-23 percent.

“With this acquisition, XTO becomes a leading Barnett Shale producer for all the right reasons,” said Bob R. Simpson, chairman and CEO of the Fort Worth-based energy company. “We are purchasing an established base of production and reserves, while securing a unique acreage position in the core area that adjoins XTO’s properties. Our team envisions a program of steady low-risk drilling, healthy economic returns, and expanding growth inventory. In short, we have added another vital development franchise for the future of XTO.”

Acquisition strategy’s downside

All is not totally rosy in the A&D world, however. In Standard & Poor’s recently published Global Oil and Gas Outlook for 2005 and 4Q-2004 Round-Up, the independent ratings service cited an increase in debt burden and other obligations, caused in part by an active acquisition strategy by many companies, as harmful to credit quality. Hedging to protect or support the likely robust prices paid is prudent from a ratings standpoint, says S&P.

“In general, the oil and gas industry seems to be in a pretty good place right now,” says the report. “Most [E&P] companies have strengthened their balance sheets and improved liquidity, the supply sector has rebounded, and even the refining industry appears to have solid margins at the start of 2005,” says S&P credit analyst Paul Harvey.

The report also looks back on the fourth quarter of 2004, when, despite record profits in the E&P and refining sectors and improving business conditions for oilfield services, negative rating actions outpaced positive actions by two to one.

“Much of this had to do with increased debt levels, or the likelihood of increases, due to acquisitions or aggressive capital spending,” said Harvey.

Positive contributions

Overall, the recent wave of mergers and acquisitions - both of companies and properties - has had a positive net effect to corporate balance sheets, according to the Energy Information Administration, a division of the US Department of Energy.

Citing M&As as a factor in rising profits, the EIA noted in January that 24 major US energy companies, many of which had been active acquirers of assets during the past year, reported overall net income of $16.7 billion on revenues of $213 billion during the second quarter of 2004. This represents a 67 percent increase over the same period in 2003.

Independent oil and gas producers reported a sharp increase in net income - up 75 percent during the second quarter of 2004 over 2Q03. Although much of this can be attributed to large increases in the prices of natural gas and crude oil, mergers and acquisitions also contributed positively to the companies’ respective bottom lines, says the EIA.

With steadily increasing demand for petroleum products and record high prices for crude and refined products, the consensus among industry analysts and participants is that prices have not yet peaked - and neither has the industry’s appetite for acquisition. OGFJ