When John Walker isn't deciding how to invest EnerVest Management Partners Ltd.'s 10th fund, he's visiting EnerVest's institutional investors or lobbying for the oil and gas industry in Washington as immediate past chairman of the Independent Petroleum Association of America (IPAA). With Walker at the helm, Houston-based EnerVest has acquired more than $1.5 billion in oil and gas properties with institutional funds since November 1994. The company currently operates more than 11,000 wells in nine states and is the seventh-most-active acquirer of properties in the U.S. this year. Its proved and probable reserves total 726 billion cubic feet equivalent (78% gas; 16.3-year reserve life) and production is 118 million cubic feet equivalent per day. The assets are primarily in the Appalachian Basin and also in the Michigan, San Juan and Permian basins, plus the ArkLaTex area and South Louisiana. Prior to leading EnerVest as president and chief executive, Walker was president and chief operating officer of Houston-based Torch Energy, where he helped the company grow from $200 million in assets to $1 billion. He was also responsible for the creation of California-focused Nuevo Energy Co., a company he took public that is now part of Plains Exploration & Production Co. Walker started his career by raising $136 million to participate in some 1,000 wells, and in 1985, he created Walker Energy Partners, which was listed on the American Stock Exchange. He received his bachelor's in business administration from Texas Tech University and his MBA from New York University. Despite the size and activity of EnerVest, a lot of the industry doesn't know much about the company. In fact, a recent speech at an IPAA luncheon in Houston was Walker's first time speaking publicly about the company's activity. Walker acknowledges EnerVest tends to fly under the radar-after all, he was part of the decision not to issue press releases. He prefers to focus on being visible to institutional investors, who are EnerVest's clients. Oil and Gas Investor sat down with Walker to find out about EnerVest's new $1-billion Fund X, issues within the oil and gas industry, and why buying C-Gas, a company associated with Enron, was like negotiating with a ghost. Investor How did you choose the operating format for EnerVest? Walker EnerVest's objective is to generate a high rate of return for our investors. We're a typical start-up story; it took us two years to do our first deal, and our first partner and our largest partner in our early deals was GE Capital. They were courageous enough to give us $350 million in six separate transactions. Those worked out very well for GE, as well as for us. Then we decided to move to the multi-institutional format and we raised our first fund in 1998. Investor Why this approach? Walker I don't know that we're 100% different than anyone else, but in what we do, there's only us and one other company-Merit Energy out of Dallas, which is larger than we are. Our ideal property purchase would be 50% proved developed producing (PDP) and 50% upside. We've been able to generate, over the course of our history, a 28.1% rate of return to our investors, after fees and back-ins. Investor What have been the effects of up-cycles for EnerVest? Walker When prices are flying high as they are right now, there's too much capital chasing too few deals. There's a lot of competition. Then all of a sudden it rolls over, as it will at some point in the future again. People who have overleveraged and have overdone things will get in trouble and have to sell off properties. Of course, we would rather buy when property valuations are much lower, but we're actually experiencing very high margins right now on the assets we have bought during the last year or two. Costs are rising, but they haven't risen as much as prices have. The reality is we're investing in up markets and in down markets, and I think one of the keys to our success is we do a lot of negotiated transactions. We have bought more than $700 million in properties this year in seven transactions and six of the seven were negotiated. Investor Why do negotiated transactions? Walker It's not what we always prefer. Usually they're complex, messy deals. But, we can probably have a somewhat better deal on price than in a competitive situation. Investor Do you feel that, in this type of market, you've almost done something wrong if you win a deal? Walker I think that's always true. Every deal you win, that means that by definition, you've paid more than anyone else, so everyone in that competition would say that you overpaid. That's just part of the process. One of our strategies that is different from some other companies our size is when buying something we evaluate when we're going to be able to sell it. Our sales process begins the day we buy it. In terms of generating higher returns for our investors, this means we can't get emotional about holding onto assets and trying to re-create ExxonMobil. We're not going to be ExxonMobil, so we might as well recognize that there's a point in time in which someone else is going to be willing to pay more for our assets than they're worth to us. Investor What would you say is your ideal turnaround period? Walker Usually in the three- to five-year time frame. In that time frame, we can at least go in, lower costs, pick over the low-hanging fruit and do the studies that are necessary to find incremental reserves that have been passed over. Investor What does your perfect purchase look like? Walker We're typically about 75% gas, but that's not by objective, it just happens that way. We typically buy things that have long lives or very high reserves-to-production ratios. We do have some regions of concentration, but we're opportunists also. So if an acquisition takes us into a new area, we will go there if we think we will eventually sell the property in that area. We're trying to find something that still has running room on it, so ideally the property would have 50% PDP reserves and we would see 50% upside. That's hard to do; you can't do that in every acquisition. Investor What are your favorite areas? Walker Appalachia, Michigan, ArkLaTex, the Permian Basin and the San Juan Basin. Investor Is Fund X the one you're working from right now? Walker Yes. It's closed now. We've done two deals in it and we're in the process of closing the third deal. It will close at the end of November and take us into two new basins. Investor How much did Fund X end up closing with? Walker It was $550 million of equity and the first purchase was Belden & Blake Corp. As a result of the leverage already on Belden & Blake, it was really a more than $700-million purchase. We gained over 300 billion cubic feet equivalent of proved reserves in the acquisition in the Appalachian and Michigan basins. Investor You did a complicated Appalachian acquisition a couple of years ago, that of C-Gas. Why did you pursue this deal through the obstacles of the Enron bankruptcy? Walker We saw first that they were the most skilled at finding the Knox formation in Ohio and we were able to retain those professionals. We thought they did something better than anyone else in that area. Investor What made it complicated? Walker It was a transaction that should have taken two months, but from start to finish, it took almost a year. This was right in the middle of the Enron bankruptcy. It was like negotiating with a ghost. No one could make a decision. They had to keep bouncing things through lawyers and we just never made any progress. I had to walk out of a negotiation two or three times. We would make a decision, then two weeks later they would reverse everything we had done. It was a nightmare. Investor Has that acquisition been productive? Walker It's fabulous. It's probably worth three times what we paid for it. Investor What is one of your favorite deals? Walker Several years ago, with GE, we bought a private company's interests in the San Juan Basin on the Southern Ute Indian Reservation. We bought it primarily because of the tax credits associated with the production. About three-quarters of the purchase price were tax credits, so we really only bought PDP reserves. During a four-year period, we had already produced as many reserves as we thought we were buying initially. We increased the reserves four-fold and sold to Texaco. You would usually think about us buying from Texaco, buying up the food chain. We had so increased the value of that property, that it became attractive to Texaco. It turned out to be a significant rate of return, in excess of 40%. Investor What was one of your greatest disappointments? Walker We've never lost money on an acquisition, so we've been lucky and successful. The biggest disappointments are acquisitions that we're very close on that we should have won. That's just part of this business. There was a large Appalachian acquisition that we effectively won, but as a result of some investor issues it was not awarded to us. In hindsight, the acquisition would have been a giant home-run, so that was very disappointing. Investor Do you think the capital markets have thrown too much money into the upstream business now, or is the money that is coming into E&P still smart money? Walker I'm not sure that any of the money is particularly dumb money; it's just a lot of money. As a result of a lot of money being available, everything is highly competitive. It's more a business of failure than success. You work very hard, but in a high percentage of transactions you work on, you're unsuccessful. Investor Has this influx of capital been bad for the business? Walker I think it's only bad for the business if we start generating bad returns for our investors. Our industry historically has not generated good returns for investors over time and we've probably taken undue risk. I don't think we're taking the same degree of risk that I've seen in the past. It's much more professionally managed, but I get concerned when a market shows all the signs of being at a peak. Investor Do you think the market is showing those signs right now? Walker Yes, but all of a sudden two hurricanes have changed the outlook for oil and gas prices. Investor What do you think about the oil and gas business' reputation? Walker Our industry has always had a bad image and I think that has to be one of our primary focuses as an industry-to explain our industry, explain all that we do for our consumer, the American public. I don't think we've done a very good job of public education. Other industries have come together and done a much better job of telling their story than we have. Investor What are the weaknesses of the domestic E&P business? Walker First, people-we have some serious workforce issues. I think younger people in college and high school have a negative view of the industry and it doesn't make them want to come into the business. We're not graduating enough engineers, geologists, landmen, and we need to do something about that. Secondly, our costs are rising dramatically. Of course, that's along with prices going up dramatically. On the national front, the government owns about 30% of the land mass of the U.S., onshore and offshore, and they're not allowing us access to drill for oil and gas resources. The vast majority of our future oil and gas reserves are on federal land where we can't drill. The United States' position is unlike that of any country in the world. Even the most environmentally sensitive European countries allow drilling where the natural resources are located. Investor What are the strengths of the domestic E&P business? Walker We're a high-technology industry. We continue to find and produce in places where it was impossible five or 10 years ago. The Barnett Shale is an example of this. In 1995, there was no production from the Barnett Shale in Texas. Today, it's the largest gas-producing area of Texas, producing over a billion cubic feet per day. Through technology and the aggressiveness of independent oil companies, we've been able to figure out how to get gas produced from those very tight formations. It's amazing, considering all the obstacles the U.S. government has created for the industry, that we've been able to maintain the levels of production that we have. Europe hasn't placed the North Sea, the Irish Sea, or any of those places, off-limits for drilling. We've placed both the east and west coasts, a lot of Alaska, good parts of the Rocky Mountains and offshore western Florida, off-limits. It doesn't make any sense. Investor What would your favorite U.S. energy bill include? Walker Access. Our biggest issue is the ability to go into these areas and drill. We're not talking about wanting to drill on a national park or a wildlife refuge. Hurricane Ivan came through last year. It was a very destructive hurricane and it came across platforms at 140 miles per hour. There wasn't a single leak from a wellbore. This was never reported. Hurricane Katrina came in and devastated the infrastructure in Louisiana, and there wasn't a single major leak from a wellbore. The technology works, but that is never reported. Investor Do you think $3 gasoline is still very cheap? Walker Relative to the rest of the world, it is, but relative to us, it's not. Gasoline is a function of crude price and refining capability in the United States. Crude price is high right now, crude availability is good, but refining capacity is the biggest issue we're going to be facing. Refining capacity and natural gas are what we really need to be worried about as we go through the full winter cycle. When you're operating on a margin and suddenly you lose six major refineries and 7%-8% of U.S. capacity, you start to have to make decisions like when to take your refinery down for maintenance and how long to make gasoline versus heating oil. As a country, are we going to run out of heating oil or are we going to be low on gasoline going into the driving season next summer? Investor Do you think Americans themselves are responsible for higher energy prices? Walker I think we have not had courageous leaders in Congress. I think we've had people who've been knowledgeable and have tried, but have been more concerned about environmentalists in making their vote rather than long-term energy development.