Marginalized in shale plays, independents are creating new opportunities for themselves
The landscape of the A&D market looks much different than it has in recent years. Though press releases on "megadeals" suggest a robust market for transactions, it would appear that smaller independents are getting left out.
Despite the tax-driven frenzy of the A&D marketplace in 4Q10, 2011 has gotten off to a much slower start. In fact, only five deals represent 73% of total transaction value year-to-date, and it is no surprise that these transactions were mainly focused on resource plays and oilier pursuits.
It wasn't long ago that smaller E&Ps were making hay selling off (or farming out) the deep rights to resource potential that sat under their conventional production. There were also many companies successful in getting ahead of the leasing activity that were able to buy-and-flip acreage to the larger independents as the market's appetite grew for the shale plays throughout 2009-2010. Though today, the land grab is over in most known resource plays, and many of the larger independents have already secured their desired positions. Moreover, the widening divergence of oil to gas pricing in the last year has been a key factor limiting acquisition opportunities for smaller management teams.
After analyzing historic pricing data available from the Energy Information Administration (EIA), the near 26:1 ratio of crude to natural gas seems unprecedented. This of course is steering the drilling and acquisition efforts of many E&Ps to the relatively few oilier plays that provide the best returns. However, more buyers for fewer deals mean higher acquisition costs, and this can make it challenging for smaller independents and private equity-sponsored management teams to execute accretive acquisitions given their higher cost of capital. So where will the smaller E&Ps find growth potential?
In the last few years, unconventional plays received most of the press, and it was almost easy to forget there were companies still focused on conventional oil and gas pursuits—perhaps this will become the trend for management teams that are unable (or maybe even unwilling) to compete for acquisitions in plays such as the Bakken, Niobrara, or the Avalon.
When the majors shifted their focus from producing in the US to pursue elephant finds around the world, the independents acquired and worked the leftovers—and as technology developed so did shale production. Now, we're seeing the majors return to apply their economies of scale and large project know-how to the resource plays as the larger independents focus on oilier shale. So as the landscape evolves, just as before, the smaller independents may once again find success from the leftovers of today's market—conventional oil and gas plays.
I've had discussions with more than a few private companies that are working to aggregate conventional Mid-Continent oil assets. In fact, word around the patch is KKR has made a recent investment into a small company that is aggregating depleted oil assets for the purpose of reworking the fields using enhanced oil recovery methods. Not surprisingly, the opportunity-rich areas for this firm are likely to be throughout the Mid-Continent.
Oklahoma and Kansas have gotten attention lately with the work SandRidge Energy is doing in the Mississippian, but check the public record for shallow permitting in Oklahoma, and you'll find a number of smaller private companies targeting some interesting objectives. The same appears to be true in Kansas.
However, opportunities should not be confined to Mid-Continent shallow oil. I'm also aware of a private company that recently closed on a $50MM joint venture with an East Coast capital provider that will fund the exploration for deep gas in South Louisiana…that's right, conventional Gulf Coast gas. I'd call it a contrarian play, but if you look at some of the success companies like Manti are having in that area, there doesn't seem to be anything contrarian about it—they've drilled deep wells that appear to pay out in less than 12 months at $4 gas.
The oil and gas industry has always been made up of a blend of risk-takers and pragmatic operators who have often been challenged with turning lemons into lemonade. As the larger independents and majors continue with the development phase of the newly found resource plays, perhaps the future Chesapeakes of the industry will be some of today's smaller independents that are now creating new opportunities from older, conventional plays. Time will tell.
About the author
Jason Reimbold is a vice president in the Houston office of The Rodman Energy Group where his focus is on A&D advisory. Rodman & Renshaw LLC (Member FINRA, SIPC) is a full-service investment bank with offices in New York and Houston. He can be reached at [email protected].
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