AUSTIN, Texas—Whether in temperate fall or scalding hot summer, the climate in the Permian Basin had the same feel in 2016: an unending “Delaware Spring.”
The highest price for undeveloped resources in the basin last year came from Diamondback Energy Inc.’s (NASDAQ: FANG) purchase of Delaware acreage from Brigham Resources for $2.4 billion. Unabated after the New Year, the first quarter of 2017 lurched forward with even more deals at a record-setting pace with half of all unconventional deal values in the quarter coming from the Delaware Basin.
For Art Krasny, managing director for Wells Fargo Securities, the next year or so is going to bring even more robust A&D activity, with the “Delaware Spring” continuing—perhaps even outside the prolific Permian Basin. He sees the Powder River Basin as a future target for companies looking to capitalize on high multiples.
“‘Permania’ is definitely driving the market,” Krasny said at Hart Energy’s Energy Capital Conference (ECC) in April. “But we also expect other areas to become more active in 2017 and beyond.”
He also noted several opportunities for deal makers this year, including 1 million-plus acres of legacy assets in the Lower 48 worth roughly $25 billion. Unconventional plays that display a disconnect between drilling returns and dollar per acre multiples are poised for price appreciation.
Outside of the Permian and the Scoop/Stack/Merge, the Powder River could be a hot ticket area, Krasny said, adding that historical trading in those areas will “tell you that the multiples on this acreage should probably be doubling.”
Bill Marko, managing director for Jefferies LLC, said that if the bid-ask spread remains reasonable the overall market could see healthy deal flow this year—perhaps more than $70 billion in transactional value.
“I think the outlook for deal flow is good,” Marko said on an A&D panel at ECC. “There’s a nice balance of supply and demand. Demand with money and ability in the capital markets.”
For instance, in the first quarter, the Eagle Ford’s transactions rang up $3.6 billion in deals—eclipsing all of 2016’s $3.1 billion, according to Raymond James.
The Money Black Hole
The character of the A&D market in the U.S. has changed dramatically in the last decade following the shale revolution.
Rick Moore, managing director for Scotia Waterous (USA) Inc., said at ECC that deal activity is now targeting nearly 80% unconventional plays.
“At some point there’s going to be a question of what do you do with the rest of the asset base if everybody wants to buy unconventionals only, but clearly it’s been the dominant source of the A&D market,” he said.
The outlet for those assets has been confined only to private companies and private-equity teams, said another speaker, Nick Woodruff, director of RBC Capital Markets’ energy investment banking group. Woodruff said he’s seen significant conventional deal flow.
A&D is beginning to follow a familiar path, with the pull for money in one basin—read Permian—causing assets elsewhere to become expendable. Sellers are typically public companies reshuffling their portfolios with the goal of selling and using proceeds in the Permian Basin.
“That’s going to be a black hole just for dollars coming in,” Woodruff said.
Another possible buyer for conventional assets, Moore said, might be some newer version of the upstream MLP that is structured differently.
While E&P deals are getting done, additional incentives are helping companies cross the dotted line.
More than ever, Marko said he’s seen price kickers facilitate deals as private and public capital markets continue to get more sophisticated and flexible.
ExxonMobil Corp.’s (NYSE: XOM) mammoth acquisition of the Fort Worth, Texas-based Bass family companies (BOPC) early in the first quarter added contingencies.
In January, ExxonMobil agreed to pay $6.6 billion for BOPCO’s Delaware Basin acreage. The deal included a series of cash payments that could add up to $1 billion that are dependent on commodity prices.
Overall, fairly stable commodity prices and continued advancements in technology are among the ingredients making for a good deal making recipe, Krasny said. Access to capital and easier agreement on prices between buyers and sellers is also helping.
Public markets are trading at a “healthy delta above the strip and that generates the positive pull for the asset market,” he said. “It’s a very conducive thing for the assets trading.”
And the bid-ask spread is much more constructive than a year ago, he said.
“It’s very easy to manage bid-ask today. Now, in cases and some instances where it becomes a problem, a healthy earnout comes into play,” he said.
For instance, ConocoPhillips Co.’s (NYSE: COP) $3 billion deal with Hilcorp included a $300 million price-driven earnout to bridge a value gap, Krasny added.
Another trend Woodruff sees is creative financing used by low- to mid-cap companies to snag “alpha deals.”
The January deal engineered by Sanchez Energy Corp. (NYSE: SN) for Anadarko Petroleum Corp.’s (NYSE: APC) 155,000-net acre Eagle Ford position happened through a partnership with private-equity firm Blackstone Energy Partners.
“That private/public partnership has …shown that really most companies can do a deal of any size, especially with the amount of capital put out there,” Woodruff said.
The Patient Publics
The industry is still in for a land rush through private transactions, with more deals to come in the Permian and Scoop/Stack, Moore said.
“People want to own that tier-one acreage and it’s hard to argue with the fact that it’s more valuable in an aggressive public company’s hands than it is in private hands, but we are starting to run out of targets,” he said. “It is not a ‘next three-month issue,’ but if you fast forward 18 months, your opportunities out there start to dwindle.”
Compared to private transactions, the corporate side of the A&D market hasn’t been as active—running at unprecedentedly low levels in the past five years, Moore said.
But that the trend is bound to change.
Private transactions have been comparatively easy for Permian acreage but public M&A may produce more headaches down the road.
”You’ve been able to get your hands on it without having to go through the brain damage of a corporate transaction,” he said. “That will run out and we’re going to find that for people to access the resource that they want, they’re going to have to go through corporate transactions.”
Moore believes that the recent slew of massive Canadian oil sands deals may be a forerunner for what’s in store in the Lower 48 as companies make massive combinations and integrate operations.
“Canada is just ahead of the curve in that way because there haven’t been the same growth opportunities within the basin so people have turned to cost structure more quickly,” he said. “In the U.S., you’ve been able to focus on grabbing the growth first and ultimately there needs to be the efficiency and optimization of basins like the Permian … once the assets are in the hands of, largely, public companies.”
A New A&D Poster Child?
Like all feasts, the Permian’s is likely beginning to taper off, especially for megadeals.
Krasny, like other A&D experts, has watched the price escalation quadruple from $10,000 an acre to $40,000 by the end of 2016.
But it’s a cycle that’s on repeat.
“When we look at this dynamic, and by the way this Delaware Spring as we call it at Wells Fargo, we see that signature repeating itself in different areas,” he said.
Looking past regional nuances, Krasny’s prediction for what’s next on the unconventional map is the Powder River Basin.
Despite a smaller rig count, “the delta between the historical valuations and what we see currently in terms of drilling results and some of the recent auction results [in the Powder River] is phenomenal and we think that this area is definitely well set up for an A&D wave,” he said.
Krasny mentioned Chesapeake Energy Corp. (NYSE: CHK), Devon Energy Corp. (NYSE: DVN), EOG Resources Inc. (NYSE: EOG) and “several other bigger public cheerleaders of the play” as possible deal makers in the Powder River.
However, a big question remains: when will the ramp-up occur?
“You have a number of private companies and private-equity-sponsored companies that have established positions [in the Powder River Basin]. It feels like it’s a very active sandbox right now and everybody is aware of that Delaware Spring dynamic—everybody knows this,” he said.
Krasny estimates roughly 700,000 net acres of deal inventory in the Powder River Basin.
In response to concerns that the projected robust A&D outlook might be too bullish, Krasny described the E&P industry as a heavy duty truck without brakes.
“And I know that it sounds negative, but I do feel like we as an industry, we exhibit that attribute. I frankly think that we’ll continue be getting a little ahead of ourselves now that we are on the upside of the cycle,” Krasny said.
Emily Patsy can be reached at email@example.com.