Eagle Ford Evolution

At a recent Eagle Ford shale conference, speakers said strong production growth was ahead for the black-oil portion, while the A&D scene in the play is open to more than just bolt-ons.

Just a few years ago, the emerging Eagle Ford play in South Texas was thought of as a gas and condensate play. But that view is dated. Today, the Eagle Ford is firmly established as an oil play, and is indeed so prolific that its production of crude is forecast to exceed 1 million barrels a day by next summer.

That was the remarkable revelation of Sub-ash Chandra, managing director, Jefferies & Co., speaking at Hart Energy's 2013 DUG Eagle Ford Conference & Exhibition in San Antonio, Texas. “The rate of growth going forward will be some 250,000 barrels per day per year,” he said. “This is nearly the same oil production as from the Bakken.”

Another conclusion Jefferies came to after studying today's Eagle Ford results was that well quality varies widely by county. Overall, wells are getting better, but location definitely matters. Three counties stand tallest in the production of crude from the Eagle Ford—Gonzalez, Karnes and LaSalle. Combined, they account for half of total Eagle Ford oil production, which currently stands at some 800,000 barrels per day. “I think what makes these wells work is a combination of strong reservoir pressures and high gas/oil ratios,” said Chandra. “We don't see this changing, as the good keeps getting better.”

Chandra noted that production statistics from Jefferies vary from those in the public database available through the Texas Railroad Commission. That's because Jefferies is primarily interested in black oil, so it excludes condensate production from gas wells.

Not surprisingly, internal rates of return (IRR) also show strong variability. In the core area, economics of Eagle Ford wells are sterling. At assumed reserves per well of 705,000 barrels of oil equivalent ((56% oil, 21% natural gas liquids and 23% gas), and an $8-million completed well cost, Jefferies figures breakeven economics are $60 per barrel at WTI prices. The IRR is around 60%, at a price deck of $95 per barrel of oil and $4 per thousand cubic feet of gas. Certain operators, such as EOG Resources, tally even more robust returns.

But when moving outside the core to Tier 1 acreage, returns are cut in half.

“About half of the Eagle Ford oil production is coming from Tier 1. So we need $75 crude to get a wellhead return of 20%,” said Chandra. For its part, Jefferies is comfortable that oil prices will not sink to those levels, and it expects the rig count to hold steady at about 170 throughout 2014.

In Jefferies' view, Eagle Ford operators are going to produce a lot of oil going forward and get great prices for it. “And the wells are going to get better: the EURs, the IPs and the total returns,” said Chandra.

This gush of new light, sweet Eagle Ford oil—combined with production from other resource plays—will likely cause regional supply imbalances, particularly in PADD 2 (Midwest) and PADD 3 (Gulf Coast). But the Eagle Ford will be advantaged in the scrap for prices, as the play has ample takeaway capacity as well as local refinery demand. In fact, Eagle Ford take-away capacity is double current volumes, allowing plenty of room for increased production. “Usually in a high-growth basin, investors worry if take-away will keep pace with growth. That's not an issue in the Eagle Ford,” the analyst said.

The Eagle Ford is also advantaged because it is not landlocked. A lot of oil is shipped out through the port of Corpus Christi, said Chandra. Jefferies estimates that some 350,000 barrels per day are going to Louisiana and Houston, Beaumont and Texas City, Texas. “This is a thriving business that did not exist several years ago,” he said. In 2014, the firm predicts the industry will explore exports far beyond the Gulf Coast, likely to PADD 1 (Northeast) and possibly the eastern coast of Canada.

And that is the new Eagle Ford production story: Strong wells, great economics and good connections to markets combine to make the play a surprising contender as a black-oil producer.

—Peggy Williams

A Play With Room For New Entries

As Eagle Ford players continue to upgrade their acreage, bolt-on acquisitions comprise the largest component of the recent transaction count in the play, but opportunities still exist for companies to enter the play, Jeff Sieler, managing director of Scotia Waterous, told conference attendees at a session on A&D.

“There are a lot of companies that are very focused on bolt-ons,” said Sieler, noting that these acquisitions accounted for 15 of the 37 transactions completed in the Eagle Ford since the beginning of 2012. Bolt-ons are being undertaken selectively, as operators that are “deep into their programs look to add site-specific” assets to their development plans, he added.

“Key operators in the Eagle Ford are very focused on bringing in additional acreage that fits in precisely with their development plans.”

Sieler described the backdrop for M&A in the Eagle Ford as encouraging, given some 134 operators in the play holding between 10,000 and 50,000 acres—what he called “the wheelhouse of companies that are looking to add on, or companies that are developing to the point of wanting to flip.”

And in spite of having recently seen “a lot of failed deals” in the Eagle Ford, he expects brighter days ahead.

“There is a great deal of interest. There are companies that want to make new entries,” Sieler said. “We anticipate seeing an uptick next quarter and certainly in 2014.” He cited growing production levels and $100-plus oil prices as reasons for “a surplus of cash and pent-up demand” for potential acquisitions, including purchases by international buyers.

“We know the international community is looking hard,” he said. “We continue to see the most interest from Asia. Europe is not out of it, but we see more interest from Asia than other parts of the world.”

In contrast to prior years, when foreign joint-venture partners tended to take on a nonoperator role, “there is an interest now to operate” on the part of potential partners from overseas, who have grown in their understanding of shale plays and business practices in the US, he said.

Transaction metrics have varied widely with location and oil content, Sieler said. For example, in an area with EURs ranging from 200,000 to 500,000 BOE, production metrics can vary from $60,000 to $140,000 per flowing barrel, although more typical is a narrower band of $80,000 to $100,000. Reserves per barrel can vary from $20 to $23 per barrel, but $20 is more likely, he said.

Acreage valuations can be “all over the place.” Where EURs and production rates are “not robust,” acreage values can fall to zero as buyers pay only for production and reserves. However, in the heart of the Karnes trough, valuations adjusted for production can be significant, said Sieler, pointing to a recent Marathon Oil Corp. transaction—with exact acreage location unknown—in which acreage was believed to command an adjusted value of “around $20,000 per acre.”

In looking at the question of whether a major acquisition in the heart of the Eagle Ford is still a profitable venture, Seiler studied the precedent of Marathon Oil's $3.5-billion acquisition of Hilcorp in 2011. He found that today, the project would generate a before-tax internal rate of return of 30%, with a present value (PV-10) of $11.5 billion, and achieve a project payout in a little more than six years. Assumptions included a fleet of 18 rigs and drilling 260 wells per year, for a total of 3,860 wells.

“This is a very robust proposition,” said Sieler. “We anticipate we aren't the only firm that is looking at it this way. We anticipate a significant uptick in the M&A market in the not-too-distant future.”

Tony Sanchez, chief executive officer of Sanchez Energy Corp., recounted his company's use of acquisitions alongside organic growth to scale up its production and reserves. To date in 2013, Sanchez has made four acquisitions, adding over 60,000 net acres in the Eagle Ford.

“We've got the bulk and the scale that we've needed and wanted to achieve,” said Sanchez. “We're focused on drilling up our position now.” Of a drilling and completion budget of $660 million next year, some $620 million is earmarked for the Eagle Ford, he noted.

He highlighted two recent acquisitions: one, called Cotulla, was bought from Hess Corp. in May 2013 for $280 million; and a more recent one, called Wycross, was purchased from a private seller for $220 million. The latter was expected to close in late September. Sanchez noted the Cotulla purchase price reflected a valuation of less than $60,000 per flowing barrel, and on a reserve valuation basis, it came in at less than $20 per barrel. “We think we got it at a good price.”

Sanchez said he also targets about $20 per barrel for reserves. But for acreage, “it's really hard to come up with an accurate average,” he said, noting that his company paid what might appear a high value in its Wycross transaction, but a low value in the Cotulla purchase.

“The truth of the matter is we are looking at reserves and production and cash flow,” he said. “We look at these deals and we say, 'Can we basically fund a one- or two-rig program with the existing cash flows, and effectively be in a position where we can self-finance each individual acquisition largely on the back of its own production and then grow reserves with that?'”

As the Eagle Ford has become more mature, the metrics Sanchez prefers to focus on are “a multiple of cash flow and a multiple of what the 'true reserves' are in the ground. So we run our own economics, and run our own decline curves, and get comfortable with what we are paying on a reserve basis.”

Are there more acquisitions to come from Sanchez?

“Our predisposition is to drill,” he said. However, the company continues to be “opportunistic.”

On the other hand, he doesn't rule out the possibility of a move in the opposite direction.

“The Eagle Ford could go through another consolidation cycle,” he says. “If there's an opportunity to exit and to do it over again for the right price, we'd certainly consider it.”

—Chris Sheehan, CFA

Trash or Treasure Acres?

With more than 350,000 potentially economic Eagle Ford acres exposed to lease expiration in the coming year, much of this land bounty will flow to high-quality operators—at the expense of less capable operators, according to Drilling-Info co-founder and chief executive Allen Gilmer.

“A lot of acreage is going to change hands to companies that know what to do with it,” Gilmer said, addressing attendees at Hart Energy's recent DUG-Eagle Ford conference in San Antonio.

“There is a great arbitrage opportunity for people that know what they're doing, and there are going to be a lot of shekels to pick up off the ground. One man's trash is another man's treasure.”

DrillingInfo graded Eagle Ford acreage by 10 categories, and found certain technologically proficient companies could wring economic value out of far-lower-grade geology than could other companies. Less-proficient companies, in fact, actually condemn their acreage by drilling two or three sub-par wells.

“The reality is, it's not bad acreage geologically. A good operator can make this economic.”

Good Eagle Ford operators produce 30% to 40% better than the median, Gilmer illustrated, and a full three times better than low-end Eagle Ford operators.

“Companies like Plains (now Freeport-McMoRan) and Marathon, which are spending the time and money understanding this, are going to be the ones left standing and able to pick up these assets on the cheap from others that have not made similar efforts.”

Ironically, sellers won't get much value for the upside, either. “It's not going to change hands with any kind of PUD (proved undeveloped) value, because they have not proven there is value in that acreage.”

Gilmer said many small operators acquired acreage, hoping service providers held the “secret sauce” to drilling Eagle Ford wells, but that's not the reality. Instead, to survive, “small companies have to learn to be fast followers.”

—Steve Toon

For complete coverage of DUG Eagle Ford, see OilandGasInvestor.com and UGcenter.com.