A panel of prominent energy capital providers recently gathered to weigh in on the latest trends in investment strategies, acquisition trends and--of course--the outlook for natural gas. The speakers presented in a boardroom-style setting at Oil and Gas Investor’s 5th annual Energy Capital Conference on June 7 in Houston.
During the roundtable discussion, the panel touched on the allure of the joint venture as a growth option and whether the trend would be ongoing, especially between large international companies and domestic independents.
"JVs are like marriages,” said Mark Bononi, senior analyst, Vedanta Energy Fund. “The new partner usually brings something to the relationship other than just money. Sometimes a company really just wants money, but we as investors want the partnership to be symbiotic.”
When partners aren’t properly aligned in their interests, it can cause problems, he said.
“Some ‘over-seasoned’ financial partners may be motivated by something other than rate of return, so they say drill just to drill. On the other hand, the company may have better economics than it normally would in these types of transactions. We want to avoid that conflict of interest. When we invest we always know there’s more to the story than the Wall Street quick math to get to the cost per acre or per barrel.”
Large, international companies buying unconventional U.S. assets has been another trend, and the window of opportunity is still open, according to the panel.
Mark Ammerman, industry head, U.S., Latin America and U.K./Europe, Scotiabank Global Banking & Markets, said during the last few months his firm has seen a lot of interest coming in from foreign buyers for unconventional gas in the U.S.
“In working through the math [NOCs] can buy the assets at a breakeven price of $4, but if they liquefy it then they can ship it to Asia and deliver it for a price that’s competitive. The difficult part of that equation is the liquefaction. But many of these companies still believe that this is an opportune time to buy.”
“Historically, the national oil companies have owned property and the integrated national public companies such as Exxon have the technology,” added John McNabb II, vice chairman, investment banking, Duff & Phelps Corp. “So what you are seeing is the NOCs trying to acquire assets and that technology. They are lacking the technology know-how on the financial and the operating side--they just don’t have it in house.”
Marty Phillips, co-founder and managing partner, EnCap Investments LP, agreed. “That lack of technology experience is a definite driver for a number of the joint ventures that we’re seeing. But eventually these large JVs with the national oil companies will be winding down. No. 1, it’s a finite universe, and most of them are busy digesting what they’ve got. No. 2, you’ve got the global economic slowdown, which has various governments more internally focused.”
Another driver for the cross-border JV trend, in some cases, has been the high well costs in unconventional plays, Bononi said.
“For some of these projects, it is easy enough to prove them up, but when you start drilling several $10-million wells in the Bakken, that’s a pretty sizable cost--but success in executing a manufacturing-style business is what the majors do.”
Several industry speculators have wondered about the ripple effects of ongoing lower natural gas prices and whether frenzied asset sales are on the horizon.
Phillips said, “You would think that $2.50 gas causes distress and reduced cash flow, and therefore creates significant acquisition opportunities. While the banks have been pretty patient, I really think the jury is still out on whether a significant buying opportunity will result.”
Ammerman noted that, by and large, his firm’s clients hedge to lock in upside and buffer against volatile commodity price swings.
“There are a few that are heavily gas weighted or dry-gas weighted that do not hedge and of that bunch, generally speaking, their leverage is to the point where, if we get into a tighter gas situation, they are going to be fine. Obviously their liquidity will dry up, and they may need to hire an advisor, but in terms of a wholesale section of the portfolio for sale, probably not.”
Some of the companies under pressure to sell assets may include smaller names that have big drilling commitments looming. Unfortunately, there are not a lot of bigger companies that want to take on the obligation to drill any kind of well at $2.50 gas, so there’s a limited buyers’ universe, Phillips said.
Cheaper gas has had some positives, McNabb said, as coal use has declined and fuel switching has already started in some power plants.
“We’re going to see it more prominently in transportation,” he added. “Hopefully we will see it in a manufacturing renaissance in the U.S.”
When the talk shifted to questions from the audience, the topics included interest from the public capital market, planning exit strategies and approaching private equity.
“Considering all of the factors that could cause the bottom to move even further down, the general market is difficult to evaluate right now,” Ammerman said. “We’ve had a lot of time and effort spent with private-equity shops during the last couple months and they are looking for opportunities in unusual places such as conventional gas and the Gulf of Mexico. But, overall, there are so many things out there that could really mess the party up, especially coming from overseas.”
However, the intuitional capital world continues to have a strong appetite for energy investments--both public debt and equity.
Phillips said, “There’s no question that the increased interest in unconventional plays has the potential to change economics and make things more challenging. But in our business there are always challenges: How much are you going to pay to get into a play? How mature is the play? How much risk is there? The increased interest can squeeze profits but it’s just part of the game.”
When EnCap partners with a management team it’s often a startup situation where there are no assets. The management team often consists of entrepreneurs that haven’t built large companies before, so they don’t have a lot of equity, Phillips said.
“We are often the vast majority of the equity at 95% to 99%; therefore we own the vast majority of the company in the beginning. Once we achieve certain benchmarks, management will earn more and more of the company. If they have assets you have to come to a common understanding of what the effective equity contribution of those assets is. We do like to have some input and influence with the companies we work with--not on the day to day operations, but we do want to be a true partner on strategy, balance sheet, capital allocation and ultimate exit.”
Phillips confirmed that exit strategy is something discussed with management teams early on.
"We are trying to use capital to help build these entities into something that has strategic value. When we are having those initial discussions we talk about time frames and the length of the investment; we talk about what we are going to build within that time frame and possible exits in various environments. We also consider the public markets, if the value makes sense--but this also depends on the management team and the overall strategy.”