HOUSTON—If 2015 demonstrated anything about the U.S. oil and gas industry’s A&D appetites, it’s that deals go with the flow.

From 2009-14, the perceived comfort zone for deal making was $70-$80 barrel oil, Craig Lande, managing director at RBC Richardson Barr, said at an ADAM-Houston Energy Network meeting in January.

“Here we are at $40-$45 and deals are getting done,” Lande said. “Not at the same clip [as past years], but I think what it shows is this industry is incredibly resilient.”

What makes 2016 different is that, barring a significant rebound in commodity prices, capital markets are tightening, less than one-fifth of production is hedged and demand is hopelessly outmatched by supply.

Lande laid out a comprehensive review of 2015, including lackluster activity, huge losses in market valuations, abandoned but still viable deals and the new “big three” plays for spending.

After a five-year stretch in which annual transactions averaged roughly $55 billion, A&D collapsed in 2015. Last year, deal values fell to $21 billion and transactions of at least $100 million dwindled to 57 from 122 deals in 2014.

The shock of 2015 should now give way to the reality of 2016. Buyers and sellers in particular have to see the market for what it is and find a middle ground in the bid-ask spread.

Amid oversupply and the price collapse, Lande posed the question, “How do you survive 2016?”

For some E&Ps, finding capital will be the chief concern. Large-cap independents will likely turn to asset sales, joint ventures or partnerships with private equity. Others will be forced to restructure out of court or by filing for bankruptcy.

Entering 2016, the upheaval in the oil and gas industry has given way to a delicate stability in market prices—enough to make deals possible.

Rebounding Down

In 2016, the A&D market will be a rebound year. Companies will scrounge for capital through divestitures, buyers and sellers should begin to see eye to eye on asset values and capital markets will cut off money to E&Ps not located in the Permian.

For sellers, wrapping their minds around assets suddenly stripped of a huge part of its value was never going to be easy. The A&D market stumbled in 2015 largely because so many deals never left the table.

“There’s probably $15 billion in failed deals last year,” Lande said.

Lande said he expects previously failed deals to be restarted in 2016.

In part, necessity will play a role. Companies are likely to see shrinking borrowing bases and tight capital markets, and many have lost the insulation from low prices offered by hedges, Lande said.

E&Ps will instead be forced to make ends meet, some by selling assets.

The bid-ask spread should erode. Lande said he expects many more motivated sellers. But they need to accept that “this is the level we’re at,” he said. If sellers can’t live with current valuations, it will be best for them to stay out of the market.

“A lot of sellers were hanging on, hoping for a better day,” said Lande, who has represented both sides of deals. “Unfortunately hope is not a great strategy.”

Lande said some buyers, too, have to temper the expectations of fire sales and “steals.” With the exception of small deals here and there, “that strategy doesn’t work.”

“With larger deals, the market is very efficient. I don’t care if we’re at $30 oil or $130 oil, core-of-core stuff is going to trade at a premium,” he said.

Lande said deals get done through a variety of ways, including creatively addressing the disparity between what sellers paid for assets and what they now have to sell at.

“Because of that bid-ask spread, we’ve got to find a way to narrow it,” he said.

One incentive is price kickers that give sellers the ability recoup money on deals based on various terms, such as six, 12 or 18 months.

“You’ve got to be creative in this market,” he said.

Who Pays?

With a supply of assets on the market, the pool of potential acquirers is expected to be parts vigorous, cautious and absent.

Public companies and private equity will likely be the largest players.

While large-cap companies are well positioned with relatively strong balance sheets, “they tend to be very patient,” Lande said. And, with many assets already in place, some have “too much to say grace over.”

However, they have the financial wherewithal to pull the trigger on assets that interest them.

Small-cap public companies, however, are unlikely to be players with their access to capital markets limited.

MLPS, too, are largely out of the game as they face liquidity issues and attempt to repair their balance sheets.

“MLPs are essentially fighting to survive,” Lande said.

That leaves private-equity firms. The huge amount of cash they have long been stockpiling—more than $85 billion—is now ready for a home.

“They see this as an opportunity to put capital to work in hopefully what is the low point of the industry,” he said.

Since 2010, private equity has increasingly made up E&P onshore A&D demand, and RBC estimates it could command half of the A&D market in 2016. Lande said there’s an estimated 250 U.S.-focused E&P management teams in play for assets.

“I’d say half have no assets right now,” he said.

Carry That Weight

In 2015, public companies largely waited as A&D opportunities stayed dormant. But there were notable exceptions, as three basins notable exceptions.

Three basins showed signs of promise and staying power: the Midland, Delaware and the Scoop/Stack area of Oklahoma.

“The Midland Basin had a great year in 2014. In 2015, the Delaware Basin really emerged,” he said.

It’s in those areas that 2016 has already seen more deals. In January, private company Luxe Energy LLC said it will buy 18,000 net acres in the Delaware. Around the same time, Concho Resources Inc. (NYSE: CXO) said it will purchase 12,000 net Delaware acres for $360 million.

Similarly, the Scoop and Stack saw deals expand, particularly Devon Energy Corp.’s (NYSE: DVN) $1.9 billion acquisition of Felix Energy. In 2015, the region generated about $4 billion in deals. In January, Lucas Energy Inc. (NYSE: LEI) said it would spend nearly $81 million to acquire Hunton Formation acreage.

Along with the Midland Basin, “those are really the three areas from a resource perspective that at least public companies are going to be looking toward if we stay in scenario of $30-$40 oil,” Lande said.

While Oklahoma’s success is new, the Permian Basin has been hot for some time. But it was the Permian that appeared to have the E&P version of rent control despite the downturn.

In the Midland Basin, despite declines in oil price, acreage valuations in 2015 stayed as good as or better than a year ago, Lande said.

The Midland and Delaware are “still trading at $25,000 and $30,000 per acre. We’ve gone down to a $45 oil environment and it’s the same price,” Lande said. “The core of the core is resilient.”

The other dominant trend of 2015 was the gobbling up of legacy gas assets.

Companies such as Devon, Marathon Oil Corp. (NYSE: MRO) and ConocoPhillips (NYSE: COP) exited conventional gas assets that have most likely been excluded from heavy capex spending for years.

The buyers that emerged were private-equity firms.

While management teams likely didn’t set out to pitch conventional gas purchases, many ended up there, Lande said.

“The neglect factor draws a lot of interest,” he said, adding that private-equity firms can cut costs by 60% while exploring largely HBP assets for upside.

Big Deals

Though trendsetters, deals in the Permian weren’t the only ones of significance.

Noble Energy Inc.’s (NYSE: NBL) purchase of Rosetta Resources validated the Delaware Basin and “started a lot of traction in the Delaware and moving away from the Midland,” Lande said.

WPX Energy Inc. (NYSE: WPX) followed with $2.8 billion acquisition of RKI Exploration & Production, a transformational Delaware Basin deal.

But Devon’s acquisition of Felix “represented the first material Stack deal in the market,” Lande said.

Encana Corp.’s (NYSE: ECA) sale of its Denver-Julesburg (D-J) Basin assets in Colorado to the Canada Pension Plan Investment Board for about $900 million caught his attention because institutions and endowments have typically relied on other companies to buy and sell assets.

“They’re trying to do it in the world on their own,” he said. “It will be interesting to see how many of them follow.”

RBC’s own Blue Whale Energy/Tall City Exploration transaction also held a new model for foreign investment. The largely-Asian joint ventures from 2010-13 were overall busts. This time, a Chinese company directly hired a U.S. management team to put a $1 billion deal together.

“It will be interesting to see if other internationals will look at the model,” he said.

Sobering Market

Last year, many analysts and other experts expected a rash of deal making.

It never got off the ground. Instead, weaker companies were extended a lifeline by equity capital markets. In the first quarter of 2015, E&Ps raised $8.1 billion, followed by $3.5 billion in the second quarter.

Only by the third and fourth quarters did equity begin to wane. Now, nearly all companies successfully raising capital are tied to the Permian Basin. Parsley Energy Inc. (NYSE: PE), for instance, has successfully raised money in both the third and fourth quarters of 2015.

Other companies suffering from the devastation of the downturn as the market values of large- and small-cap E&Ps and MLPs have seen their worth dissolve very rapidly.

Lande said RBC calculated the “value destruction” across all E&P sectors in the past 18 months when oil started its dive off a cliff.

All told, companies lost a staggering $1 trillion in value as oil prices degraded and companies wrote down the value of assets. MLPs in particular were crushed, losing 94% of their market value.

For the rest of the U.S. E&P universe, times are about to get tough.

Roughly 18% of U.S. production is hedged in 2016. Small-caps and MLPs are worse off, despite higher hedges, because of high leverage levels.

For companies that lack hedges and don’t have cash flow to service debt, “that’s going to create asset sales,” Lande said.

Darren Barbee can be reached at dbarbee@hartenergy.com.