The normal pace of U.S. upstream deal flow slowed—but only slightly—to $21 billion in the first half of 2012, as both natural gas and oil prices hit near-term lows. Natural gas bottomed at a spot price of $2 per MMBtu, $3.27 per MMBtu for the three-year strip, and oil fell below $80 for the spot price, about $85 per barrel for the three-year strip, causing a market slowdown that has extended into the third quarter. Nevertheless, firming commodity prices have raised hope that deal flow could reach its normal full-year average of $60- to $70 billion.

Three distinct buyer groups emerged in first-half 2012: public independents and master limited partnerships (MLPs), large generalist private-equity funds, and international companies.

In both number of opportunities and total deal flow value announced during the first half, the largest buyer group was opportunistic public independents and MLPs. The active buyers are familiar names that always have their eyes on buying opportunities. They are skilled acquirers, understanding what it takes to win public auctions and knowing how to access exclusive opportunities. In the first half they included Apache Corp., Concho Resources, Halcon Resources, Linn Energy, Marathon Oil (now an independent E&P) and SandRidge Energy.

The second buyer group—and one that spent nearly the same amount as the independents and MLPs—was made up of the large, generalist, private-equity investors. These included Apollo, GSO Capital Partners (Blackstone), KKR, Riverstone Holdings, TPG and others. As a group, these investors have generally been underweighted in energy investments. But in the past couple of years they have seen very attractive macro factors emerging, especially in U.S. natural gas pricing, and they see today as an attractive time for energy investment.

International companies form the third buyer group. Some entered the U.S. in the past few years, and their peers have followed. Their level of activity in evaluating deals and their knowledge base continue to increase. Korea National Oil Corp., Marubeni, Osaka Gas and Sinopec led the group of internationals announcing deals in the first half of 2012. The group continues to be driven by the desire to invest in hard assets that offer potential upside, a window into new technologies and a physical hedge against rising commodity prices.

Independents And MLPs

In a large growth-oriented deal announced in January, Apache Corp. purchased liquids-rich Anadarko Basin assets (Granite Wash, Cleveland, Tonkawa and Marmaton plays) in Cordillera Energy Partners III from Cordillera management, EnCap and other investors for $2.85 billion in cash and stock. As the name implies, this was Cordillera’s (and EnCap’s) third successful build-and-sell effort.

In April, Halcon Resources (led by Floyd Wilson and much of the old Petrohawk group) continued to build size quickly, buying GeoResources in a $1.06-billion cash-and-stock merger. This added Bakken and Eagle Ford acreage and production to Halcon. They followed this up with a $369-million cash-and-stock purchase of Woodbine assets from an undisclosed seller.

In May, Concho Resources agreed to acquire Three Rivers Operating Co. (backed by private-equity investors Riverstone Holdings and Carlyle Group) assets for $1 billion in cash. The assets are focused in the northern Delaware Basin, Midland Basin Wolfberry, Wolfcamp and Cline shale-gas plays.

On the MLP front, Linn Energy continued its acquisitive ways with four deals: two gassy asset acquisitions with BP, a joint venture with Anadarko Petroleum, and a smaller, unnamed East Texas acquisition. First in February was its $1.2-billion acquisition of BP’s Hugoton assets in Kansas. The production profile for these assets is an ideal fit for an upstream MLP. The second, announced in June, is a purchase of BP’s Jonah Field assets in Wyoming for $1.025 billion. In between the two BP deals, Linn announced a joint venture for $400 million with Anadarko in its Wyoming Salt Creek Field. For this oil deal, Linn’s stated strategy parallels those of the internationals: it is entering the Salt Creek EOR deal to learn and ultimately apply technologies to its other assets.

MLP Vanguard Natural Resources announced a $445-million acquisition of Antero’s Woodford and Fayetteville production and acreage. In addition, KKR-backed Premier Natural Resources announced a $306-million acquisition of WPX’s (formerly Williams upstream) Barnett and Arkoma Basin assets. These deals reflect the emerging trend of (relatively) more mature shale-gas assets being attractive to upstream MLPs. 

Marathon Oil continued its focused pursuit of growth as a new independent E&P with a bolt-on Eagle Ford shale acquisition of Paloma Resources for $750 million. 

Finally, in a surprising deal in February, SandRidge Energy announced a $1.275-billion cash-and-stock deal to buy Dynamic Resources, a Gulf of Mexico-focused company. SandRidge, which now concentrates on the Permian Basin and Mississippian Lime plays, will apply free cash flow expected from the Dynamic assets to its future onshore developments.

Private Equity

The largest deal of the first half of 2012 was announced in February. EP Energy, backed by Apollo, Riverstone, Access Industries, KNOC (along with other unannounced consortium members) announced a deal to buy the former El Paso upstream assets (now called EP Energy) in a $7.15-billion deal. This deal was completed in May, closing in parallel with the Kinder Morgan purchase of El Paso Corp. When Kinder Morgan originally announced the acquisition of El Paso Corp., it stated the intention of selling off the upstream assets simultaneously upon closing El Paso and this plan was successfully executed.

In April, Chesapeake Energy announced three asset monetization deals, raising a total of $2.6 billion. The first was a sale of preferred shares in the newly formed Chesapeake Tonkawa LLC for $1.25 billion. The investors were led by GSO Capital Partners (a Blackstone Group affiliate), and also included TPG Capital, Magnetar Capital and EIG Global Partners.

Chesapeake also announced its 10th volumetric production payment (VPP) transaction with Morgan Stanley. This deal raised $745 million and is in the Anadarko Basin Granite Wash play. In the third transaction, Chesapeake sold Woodford shale assets for $590 million to ExxonMobil’s XTO Energy subsidiary. This continues an ongoing trend for the mega-majors, bolt-ons to their existing previous large asset or corporate purchases in the shale and resource plays.

The Internationals

While the EP Energy deal also had an international component, with KNOC as a named investor, there were other interesting deals completed by international companies in the first half.

In January, Devon Energy announced a five-play U.S. joint venture with China Petrochemical Corp. (Sinopec) for $2.2 billion, $900 million in cash with the balance in a drilling carry. This is a relatively early-life joint venture and is one of the few shale/resource joint ventures with assets in multiple plays, as the vast majority of joint ventures to date have been focused on one specific basin. 

In another international deal, Japan’s Osaka Gas agreed to a joint venture with Cabot Oil & Gas in Cabot’s Pearsall shale acreage interest for $250 million in a 50/50 cash-and-carry deal. Osaka had recently announced liquefied natural gas (LNG) offtake agreements from the Freeport LNG project in South Texas.

Finally, and also in South Texas, Marubeni agreed to a joint venture with Hunt Oil in its Eagle Ford acreage. While the deal price was announced as $1.3 billion, that total includes the cash, carry and the future Marubeni interest development cost. The initial purchase price was not publicly disclosed.

This announcement demonstrates that for joint ventures, the headline announcement of the deal—cash plus carried drilling to acquire a certain percentage of the acreage—is just one part of the story. The actual commitment of long-term capital by the new partner to fund its own share of the interest is much larger, depending on deal specifics—easily two to four times larger than the initial acquisition cost. So, a several-hundred-million-dollar joint-venture transaction is really a billion-dollar commitment, and a billion-dollar joint venture deal results in a multibillion-dollar capital commitment from the partner.

Stronger Second Half

As the second half of 2012 began, we looked for deal flow to pick up as confidence returned to the market with strengthening natural gas and oil prices. There is continued buyside interest from private equity, international investors, independents and MLPs. Even the mega-majors, who collectively have amassed tens of billions of dollars in cash, may continue their acquisitive ways.

Throughout July and into early August, as this article went to press, these groups continued to actively acquire, both in and outside the U.S. CNOOC (China National Offshore Oil Co.) announced a deal to buy Nexen Inc. for more than $15 billion in cash, and Sinopec announced a $1.5-billion investment in Talisman’s North Sea assets. Sumitomo announced a $1.4-billion joint venture with Devon Energy in the Cline and Wolfcamp Permian Basin shales, and KKR announced a deal with Comstock Resources in the Eagle Ford.

Finally, as we near the November elections, some sellers are keen to accelerate sales ahead of what could be higher capital gains taxes in 2013. With $21 billion in deals in the first half of 2012 and a historical average of $60- to $70 billion in deals each year since 2009, it is likely that the second half will be stronger than the first half of the year in terms of deal flow or deals announced. Stay tuned.