The oil crash has forced companies to cancel or delay projects and cut almost 150,000 U.S. jobs over the last two years; and more than 1,500 rigs in the Eagle Ford and Permian Basin have been idled.

For seasoned professionals like IOG Capital’s founder Marc Rowland, who has been in the industry for more than 40 years, this downturn is just another one for the books.

“The industry quickly rebounded in 2010, only to see the most recent collapse beginning in second-half 2014. We’re either near or at the bottom currently, and oil and gas prices have rebounded pretty significantly off of their lows,” Rowland said as he addressed the crowd at Hart Energy’s recent DUG Permian Basin conference.

So what went wrong this time?

To start, there was too much emphasis on nonproducing assets, according to Rowland.

“I believe the focus by the industry on the acquisition of nonproducing acreage instead of a balance of PDP [proved developed producing reserves] and acreage was a mistake, especially when combined with high leverage,” he said.

“That didn’t mean the acreage wasn’t productive or at least highly prospective; it just resulted in the balance sheet assets shifting from cash flow-generating PDP to cash flow-consuming acreage,” he said.

Rowland said few people talk about the important issue concerning dependence on internal rate of return (IRR) vs. return on invested capital (ROIC).

“For all of you guys who generate slides or go off slides, internal rate of return at the well level became the mantra of many companies; and I can remember seeing projects that were 100% rate of return or 80% rate of return and all of their projects were above 60%. Company after company, slide after slide, year after year starting in about the mid-2005 [or] 2006 range, [and] there was never any mention of return on invested capital.”

Other contributing factors include too much debt, too much emphasis on acquiring acreage and flipping, and little evaluation of massive development capital required after acquiring acreage, he said.

“There wasn’t enough emphasis put on evaluation and how much money was going to be required to develop properties,” Rowland continued.

“And so private companies were able to raise $1 billion to $1.5 billion and buy a lot of acreage and count on the fact that they could either go public, or raise private equity, or raise any kind of equity or initial debt. Then the downturn came and they were in an unenviable situation with having nonproducing assets. Very little development drilling was accomplished relative to the vast number of unbridled locations for which substantial investment had been made, frequently capitalized with debt.”

Looking ahead

Moving forward, potential successful projects include the core Bakken, Stack, Scoop, core Utica/Marcellus, the Permian, Midland and Delaware basins, the Eagle Ford and a few other small areas such as the Austin Chalk, according to Rowland.

“What would be a potential successful project today? Well first of all, you’re going to [need to] be in the best of the best plays,” he continued. “[Operators] have to have acreage already in hand; have to be economic at today’s costs, including the percentage per acre within the midstream; be a strong operator [with] technical ability, cost control and a balance sheet; and then there has to be some size to the potential.

“My observation about where we are today is, the cycle is probably going to continue on for at least another year—gas even longer than that. I think it’ll take a year-plus from now to balance supply and demand,” Rowland said.

Rowland offered the following observations:

  • Gas is amply supplied with gradual demand growth;
  • Banks won’t be active soon, and costs will increase;
  • M&A remain slow due to increased equity requirements and volatile pricing;
  • The service industry will take six to 12 months to gear up after a return to a more normal environment;
  • Direct ownership structures such as DrillAdvance (IOG’s joint development agreement) or project-specific private equity will be available;
  • The industry is one-third to halfway through the bankruptcy/restructuring cycle, whether in or out of court;
  • Focus will return to ROIC vs. IRR;
  • Focus will return to PDP and known development vs. new acreage or drilling inventory; and
  • There will be regulatory challenges.

“Banks won’t be active soon. Some costs will increase for those few banks that are active today, and that will remain slow, in part due to the inability for the banks to step in and finance any kind of reasonable terms,” Rowland said.

“The service industry will continue to lag. After oil returns to somewhere near $60 and there’s this vision of remaining strong [stronger than it has been], it’ll take the service companies six months to a year to re-staff and re-equip and get back to business.”

Ariana Benavidez can be reached at abenavidez@hartenergy.com.