Gulf of Mexico Revival

Despite waning oil prices and lateral movement of Henry Hub, onshore transactions continue to inundate the market. The supply of unconventional resource opportunities with huge undeveloped upside and the potential for strong returns are factors driving heightened activity in the Lower 48. A key producing basin that has quietly remained at the mere fringe of this trend is the Gulf of Mexico.

In a post-Macondo era, Gulf of Mexico transactions have been understandably sparse. Uncertainty over environ mental regulations and renewed appreciation for complex, expensive drilling programs have turned buyers away from the area that represents nearly a quarter of our country’s oil production, according to the Energy Information Administration. In 2012, only one corporate Gulf of Mexico transaction has occurred, and deals are well below 2010 levels.

Yet there are plenty of reasons to believe the water’s fine.

With Macondo behind us, the regulatory environment appears to be easing off the post-spill clamp down. For instance, the average time to obtain a jack-up rig has dropped from 132 days in 2011 to 67 in 2012 (Bureau of Safety and Environmental Enforcement). While this is high compared to a 26-day average prior to the Deepwater Horizon explosion, it gives credence to a more amenable offshore permitting environment going forward.

Gulf of Mexico Rig Count

More importantly, two years after the six-month deepwater drilling moratorium was instated following Macondo, the deepwater rig count stands at 29 with an additional 11 rigs contracted for the upcoming year. This is within the 25 to 30 pre-Macondo range and just shy of the high watermark of 32 deepwater rigs in 2007. Meanwhile, the total rig count (shelf and deepwater) has followed a markedly improved trend since 2010.

Recent transactions, such as Sand-Ridge’s $1.3-billion acquisition of Dynamic Offshore Lucius and Anadarko’s $556-million sale of its 7.2% stake in the deepwater project, could be the first data points in a trend of Gulf of Mexico transactions that have already surpassed 2011 levels.

We can also look to government lease sales to gauge offshore interest. The Central Gulf of Mexico Lease Sale 216/222 last June was the first of its kind in over two years. The federal auction blew away expectations with $1.74 billion in sales for 454 tracts, almost doubling the $949 million raised in March 2010.

With onshore shale deals getting most of the attention these days, who are the likely investors in the Gulf? Arguably, the same buyers who are looking at high-PDP (proved developed producing) assets, but can handle the drilling costs and development risk of offshore operations.

While emerging resource plays can potentially yield strong returns even in an $80 WTI price environment, many investors prefer producing assets to assure some certainty of cash flow. According to IHS Herold, second-quarter conventional producing asset sales (greater than $20 millon) were dominated by yield-oriented buyers such as: Linn Energy, LRR Energy LP, Legacy LP, Eagle Energy Trust and Memorial Production Partners LP. The only private-equity buyer in this screening was Morgan Stanley’s Trinity CO2 , which acquired SandRidge’s EOR properties in the Permian Basin.

Gulf of Mexico Transactions By Type

So how are cash-hungry, returns-oriented private-equity groups supposed to compete with MLPs (master limited partnerships) and CETs (Canadian energy trusts) bidding up to 10% discount rates? The answer could lie in offshore Gulf of Mexico. Just this quarter, private-equity titans Apollo and Riverstone committed $600 million to invest in Talos Energy to explore the Gulf shelf, while Warburg and Temasek went for the deepwater by backing former Nexen management with a $1.1-billion stake in Venari Resources. In February, River-stone and Carlyle demonstrated the potential rewards of investing in Gulf of Mexico with a 3.6x cash return on the sale of Dynamic Offshore to SandRidge.

Financial investors represent an increasing portion of natural resource buyers. Private-equity deals in the energy industry nearly doubled from 2010 to 2012, representing an increase in total transaction value from $17.5 billion to $33.3 billion. With a rebounding American economy seeking higher return assets, investment funds are looking to energy as an appealing sector due to historically strong performance and an even better outlook. For well-capitalized investors with risk tolerance and access to strong management teams, the Gulf of Mexico may be an attractive investment at current valuations.

If you are interested in getting your feet wet, timing couldn’t be better with many offshore deals on the market. Newfield, Marathon, Petrobras and BP are just some of the recognizable names with Gulf assets for sale. One private-equity-backed operator reported being shown at least 12 offshore opportunities. The environment is ripe for deal making as overexposed sellers seek to unwind their Gulf of Mexico portfolio and returns-oriented buyers are warded away from competitively priced onshore producing deals. With the right operator, now may be the time for financial buyers to bolster their offshore positions. In fact, savvy investors like Apollo and Warburg may already be ahead of the curve.