?The upstream A&D business has experienced a steep change that has left the marketplace reeling and somewhat confused. With the collapse of both oil and gas prices and the capital markets in the last half of 2008, acquisition metrics have no doubt been adjusted downward, but so few transactions have been completed in recent months that the market is unsure exactly where reserves are currently trading.
Deal suppressants. Close ratios have plummeted in the past six months due to a chasm between sellers’ expectations and what buyers—using adjusted price decks—are willing to offer. The robust cash flow enjoyed by producers in first-half 2008 lingers vividly in sellers’ minds, yet buyers are quick to adjust to the newest forward strip.
The market today is probably best described as dormant. A review of deals currently on the market quickly reveals that many packages are well past their bid dates and that few new assets have come to the marketplace. This lag in A&D activity is attributable to three primary issues.
• Companies and individuals do not want to sell assets at what is perceived to be the bottom of the market and in the face of oil and gas futures curves in contango.
• Despite reserve write-downs, impending bank redeterminations and a reduced borrowing base, the real financial pain of the 2009 oil- and gas-price collapse has yet to be fully reflected on income statements.
• Sellers are concerned that potential buyers don’t have the borrowing capacity to close large transactions with the capital markets in disarray.
Almost all producers have initiated cost-cutting measures to enable them to live within their adjusted cash-flow forecasts. However, if oil and gas prices stay at or below current levels, many producers will be forced to identify nonperforming or noncore assets and take them to market, undoubtedly under a tight timeframe, to raise cash, alleviate bank pressure and supplement cash flow.
Upside of down metrics. Based on The Oil & Gas Asset Clearinghouse’s December auction results, which is one of the few market tests since late September, there are still many ready, willing and able buyers, all hoping for bargains. The December auction witnessed a high bidder-to-lot ratio and impressive credit lines. There is no doubt that the current price environment offers more price-related upside than has been enjoyed for several years.
A review of one metric during the price-upswing period from October 2007 through June 2008 reveals that working interests, weighted by barrel sold, averaged $68,741 per flowing barrel of oil equivalent. For the subsequent period, from July 2008 through December 2008, the average dropped 36% to $43,751.
Royalties, on the other hand, seemed to be somewhat impervious to the price collapse and actually increased in price during second-half 2008; however, this can probably be best explained by the quality of the royalties sold during this time frame.
Many individuals and companies are not over-leveraged and have ample capital available to acquire assets at what they hope are distressed prices. For these very reasons, any deal that is properly and broadly marketed will enjoy competitive bidding and strong metrics.
One question that is constantly asked is, “What are reserves selling for today?” Unfortunately, there is no simple answer because, regardless of market conditions, transaction metrics (present value, cash-flow multiples, and price per proved and flowing barrel) are dictated by the production profile of the asset.
Cash-flow multiples and price-per-flowing-barrel-per-day valuation metrics will always be higher for long-life reserves and assets sporting economically viable upside than they will be for shorter-life properties. Present-value and price-per-barrel metrics for proved reserves will be better for short-life reserves than for long R/P (reserve/ production) assets.
Cash-flow multiples vary considerably by basin, but will generally be the same as in the past. However, monthly revenues have obviously decreased, thereby reducing the overall sale price. Lastly, upside metrics will drop materially in a lower price environment.
Mergers over assets. Strategic acquisitions will be less common in 2009 than in the past few years. Public companies that had a tendency to pay premiums for new core areas or to enter a new play are now awash in undrilled leasehold positions and short on discretionary capital.
Just the same, don’t be surprised to see strategic mergers occur that leave the surviving entity with an acceptable debt-to-equity ratio, and a borrowing base sufficient to capitalize on its newly consolidated growth platform.
—Kenneth R. Olive Jr., president, The Oil & Gas Asset Clearinghouse, 281-873-4600.