Thus far, 2015 has proven to be an interesting year in the E&P space. U.S. transaction activity, which averaged approximately $8 billion per month in 2014, only recently eclipsed the $2.5 billion mark for total year-to-date transaction value in early May. Companies that once had healthy balance sheets have seen their leverage profiles change drastically, and many have found themselves with unhealthy levels of debt.

Leverage issues coupled with the impending credit facility redeterminations have pushed companies to the equity capital markets to alleviate capital constraints and reposition their balance sheets. Generally, these follow-on offerings have been well received, indicating stronger than expected institutional demand for energy investments. Although the M&A market has remained relatively dormant through the first four months of 2015, continued investor interest and capital influx into the energy space should act as a catalyst for transaction activity in the second half of 2015 into 2016.

Despite depressed equity valuations, there has been a considerable amount of equity capital markets activity through April of 2015, resulting in 22 follow-on offerings ($8.5 billion) including 15 bought deals. Over the same time period in 2014, there were only seven follow-on offerings ($1.6 billion), none of which were bought deals. The uptick in bought equity deals indicates two trends: companies’ desire for lower-risk alternatives to raising capital, and a surplus of investors looking to put capital to work in the exploration and production space.

Creative approaches

Private capital has begun and will likely continue to look for more creative methods of placing capital in the public markets, as evidenced by recent equity injections and other alternative financings. Linn Energy and BreitBurn Energy Partners, for example, have recently engaged in partnerships with private equity (Linn with GSO and Quantum, and Breit­Burn with EIG).

In January, Linn announced that it had entered into a drilling partnership with GSO. The $500 million of capital committed by GSO will be used to fund oil and gas development. Under the agreement, GSO will fund 100% of the drilling costs and receive an 85% working interest until a 15% internal rate of return hurdle is achieved. This deal has allowed Linn to raise capital without increasing leverage, while adding a growing cash flow stream without capital costs for unitholders.

In March, Linn also received a commitment for $1 billion in acquisition capital from Quantum Energy Partners. Under the terms of this agreement, Linn will manage the assets while holding a 15% to 50% stake. This structure provides Linn the ability to take advantage of depressed valuations in the market through acquisitions, while reducing the level of upfront capital or balance sheet exposure they would have to commit.

Similarly, BreitBurn completed a private offering of convertible preferred units and senior secured notes to EIG. The proceeds from this offering are expected to be used to pay down borrowings under its credit facility.

These highlighted transactions could serve as a blueprint for partnerships between private equity and companies that may have balance sheet-related constraints. Private equity has provided these companies greater access to capital, allowing them to, in some cases, clean up balance sheets, and putting them in a position to be opportunistic around development and acquisitions.

Given the surplus of energy focused private-equity capital available (approximately $75 billion was raised in the past 12 months), other capital-hungry companies and companies looking to make acquisitions at historically low prices are likely to follow suit. The increased investment in oil and gas companies will allow for more manageable balance sheets across the industry, ultimately serving as a catalyst for increased transaction activity.

—Buddy Carruth and Robert Urquhart, Scotia Waterous, 713-437-5045, buddy.carruth@scotiabank.com