An oil industry axiom says that the biggest fortunes are made by investing at the bottom of the cycle when others are looking for the nearest exit. If this is true, there is no time to waste. It must be the right time to get going—especially because oil prices have climbed quite a bit from their low point, which will only amp up the competition and make assets more expensive in the next few months than they’ve been in the past year.

An energy-focused private equity stash of $80- to $100 billion is in place as well, with a lot of that capital being spent on small A&D transactions already. Jefferies LLC has counted at least 13 deals since October 2015 of greater than $100 million where the buyer was a private-equity-backed private E&P.

But throughout the downturn, some of that private equity has been looking further ahead by committing capital to E&P start-ups that haven’t made any acquisitions yet. The crop of new E&Ps ranges from small shops backed by energetic folks in their 30s with few employees, to high-profile executives such as Mark Papa, the retired EOG Resources Inc. chairman who IPO’d his Silver Run Acquisition Corp. in February. His partner in the endeavor is private equity’s Riverstone Holdings LLC.

Needing a dose of optimism in the face of current realities, we decided to take a look at three new E&P companies poised to start deal-making: Oak Ridge Natural Resources LLC, Scala Energy LLC and Tall City Exploration II LLC. Each one is seeking foundational assets from which to grow.

The Oak Ridge Natural Resources team is on the hunt. Left to right: CTO Brian Wheeler, CEO Chris Jacobsen and CFO Robert Grisaffe.

Never a better time

“We’re pretty busy,” said J. Chris Jacobsen, president of Oak Ridge Natural Resources LLC in Tulsa. When it was funded in June 2015, WTI was about $60/bbl, but the price headed south thereafter. He was not deterred; on the contrary.

“We saw the downturn as being an opportunity, and we know that from change comes opportunity. As we started discussions with Kayne Anderson, we kind of embraced it with enthusiasm,” he said.

Being aligned with the right equity provider is critical, Jacobsen said, and Kayne Anderson Energy Funds’ new $1.5 billion Kayne Private Energy Income Fund was being raised around the same time he was looking for an appropriate capital partner. Because Kayne’s investing team is comprised of financial and technical people, many of whom worked at Netherland Sewell & Associates Inc. (NSAI) and other well-known companies, this was particularly attractive; Jacobsen was employed at NSAI from 1982 to 1994, so he was comfortable with the mindset of his financial provider going in.

As he begins, Jacobsen can check the right boxes for his start-up: engineering and basin expertise, and alignment with the capital provider. The type of capital turns out to be just as important as the amount, he said. “This is a lower cost of capital structure that allows us some breathing room. We feel we can be very competitive in a sales or auction process where we like the oil and gas properties.”

Oak Ridge has no properties yet, but it is looking in the Midcontinent, East Texas and North Louisiana and “certain places in the Rockies where the team has experience, and so we’re not intimidated by it the way some others might be.”

With a clean balance sheet, a $300 million equity commitment from Kayne (and the option to upsize that funding if warranted), plus reserve-backed debt financing, Oak Ridge could be in the right place at the right time when A&D deal flow picks up.

At the time it was staked though, very few assets were coming to market, given that most E&P executives were still reeling from the shocking downdraft in oil prices, which in turn had widened the bid-ask spread. But the market seems different to Jacobsen, even as recently as in the past 45 days, he said.

“When we came out in June 2015, we saw, quite honestly, there was more capital available than there were properties to be bought. Now we are seeing deals hitting the market every week, and they have size and scale,” he said. “We’re looking for an anchor deal to provide us an asset from which other acquisitions would be accretive.”

A sizeable package could be on the Oak Ridge radar screen, for when asked what sort of deals he is evaluating, Jacobsen said, “Well, there is only one other new E&P company in the Kayne Private Energy Income Fund, and that is Terra Energy Partners, which just paid $910 million to buy WPX Energy’s assets in the Piceance Basin.”

Jacobsen’s assembled a team that worked together previously at Premier Natural Resources under Charlie Stephenson, former CEO of Vintage Petroleum Inc., in Tulsa. Most have been together at least 10 years scouting and closing acquisitions, so they know the drill and know each other well.

“We have an evaluation process that everybody knows, that is tried and true. That’s really the heritage that comes from all of us having worked with Charlie and from that attention to detail. Many of us have a 30- or 35-year career, so we have that broad perspective.”

Senior vice president and chief technical officer Brian Wheeler was in Vintage’s acquisitions group and evaluated properties; before that, he was at Exxon. Senior vice president and CFO Robert Grisaffe was an auditor with KPMG, who focuses on tying projections back to actual cash flow and operating costs.

Oak Ridge will face plenty of well-funded competition for properties from the many private E&Ps on the hunt, but Jacobsen said he is not worried. “When we talk about this opportunity, I tell our guys, patience is not one of my virtues, but attention to detail is. If we cannot be value accretive on something, we’d better move on to the next one. We are screening a lot of deals because we need a combination of existing production and upside; we aren’t pursuing straight acreage deals.

“We’re not at all discouraged. It’s just a matter of time. What we want to communicate is that our enthusiasm for acquiring assets has never been higher, going all the way back to the 1980s.”

Scala on the hunt

Houston-based Scala Energy LLC was formed in July 2015 with an initial commitment of up to $500 million from EnCap Investments LP. Once president and CEO Steve Hinchman made the decision in February 2015 to start a company, and he had assembled a team, he did due diligence on 22 private equity providers before finding what he called the right cultural fit with EnCap, he said.

Scala’s seasoned team brings more than 200 years of experience across virtually all North American unconventional plays to the venture; Hinchman alone has 35 years. He previously was CEO of HighMount Exploration & Production LLC until it was sold in 2014 to EnerVest Ltd., CEO of Callon Petroleum Co. before that and executive vice president at Marathon Oil Co., where he was responsible for worldwide production and exploitation. He has a master’s in petroleum engineering from the Colorado School of Mines.

Scala is Latin for “to climb.” As Hinchman explained, “We’re always looking to climb and reach that pinnacle for an E&P company.” He said he is not an avid climber and in fact is scared of heights—but he’s not scared of the current environment. He thinks A&D momentum is finally building after a long lull; he always thought second-half 2016 would be the optimum time to pull the trigger on a deal.

“We’re starting to see improvement in the quality of the assets being offered,” he said, although he is a bit frustrated that deal flow is still only about half what it was during the past five years.

“There are two types of sellers out there: sellers that have stress and are pressured to delever, and sellers who are perhaps more strategic in their thinking; for example they are in three major basins but might exit one to focus on the other two.”

Scala Energy can consider deals from $300 million to $1 billion. “Having a higher amount of private equity available to us is very important,” Hinchman said, “because I think there is a lot of competition in this market. One way you distinguish yourself is to be able to access a large enough amount of capital to acquire quality acreage, although it doesn’t eliminate competition.”

After HighMount was sold in October 2014 for $805 million, Hinchman received a number of offers to be the CEO of companies, some large and some small. “But we were still looking at $95 then, and it just didn’t feel right to me—I thought I’d be jumping back into the same fox hole.

“We’re in a unique period in the industry now and that’s what got me interested in looking at private equity instead. I like the idea of starting with a clean balance sheet and a tailwind at our back instead of a headwind.”

He said the team he’s assembled is best suited to the industry’s recent shift from a lease-and-drill strategy to the acquire-and-exploit business model. Vice president of development Dave Sneed was in charge of exploitation in the Lower 48 at Marathon. Co-founders Allen May and Andy Lundy were colleagues at HighMount. They plan to optimize unconventional assets that have been partially derisked in the core or proximate to the core.

“Our goal is to use our technical and operational expertise to optimize assets by engineering the fracks to improve recoveries and derisk additional pay zones, to add to our inventory, looking at the optimum number of wells per section, and of course, exploring ways to lower costs. These are all things this team has spent most of their careers doing.”

The initial focus will likely be on the Permian, Eagle Ford and Bakken areas, since Scala is less interested in natural gas plays. Although he likes the Scoop, Stack and Niobrara plays as well, Hinchman believes it might be difficult to buy anything in the core of those plays.

Tall City’s Permian encore

President and CEO Mike Oestmann’s biggest problem is that he has a tough act to follow—the Tall City I team. In November 2014 and again in November 2015, Tall City I sold Permian Basin assets for a total $1.2 billion. Backed by Denham Capital then and now, the latter has anted up a commitment of $300 million, which closed in May, to fund the second version of Tall City, based in Midland.

Key members of the prior team are back, including these vice presidents: engineering and operations, Gary Womack; CFO Michael Marziani; land, Angela Staples-Guerrero; drilling Dennis Kruse. New to the team is vice president of geosciences and exploration Chris Cuyler.

While he knows expectations will be high, and that the Permian Basin is highly competitive, Oestmann is upeat. “We’re just getting under way here. It’s an amazing business, that after all these years you can still come up with new ideas. In tall City I, we had a well offsetting the original discovery well for the Permian. The fact that you can drill a horizontal well 100 years later and get 1,000 bbl/d is mind-boggling.”

This time, Tall City II will add focus on the Delaware and Central Basin Platform, where horizontal applications are making a huge difference in well recoveries. He and Denham agreed the new company should broaden its horizons beyond the Midland Basin of Tall City I to see a bigger set of opportunities. For example, many observers thought previously that Howard County wasn’t prospective—today’s well results show otherwise.

At the same time, there is a new dynamic afoot facing all Permian companies: lower oil prices yet better technology, combined with many additional players also looking to strike Permian gold. “It’s crowded and competitive here, there’s no question about that—we’ve already passed on some deals because we just can’t pay that much for acreage.

“But we’re confident in our team. After all, we built the first company at $100 oil, sold it at $40 and made a great return for our investors. We’d like the chance to do it again now at the current price, and maybe sell later when oil is even higher. We’re not counting on the price increasing, but it would certainly fit well with our strategy.

“We still like the Permian better than other places.”