A Billion Chinese Dollars In The Permian

In a sign of China’s continued interest in U.S. shale, private-equity backed companies Tall City Exploration LLC and Plymouth Petroleum have a deal to sell their Permian Basin holdings in Texas for more than $1 billion to Moss Creek Resources LLC, a Houston-based subsidiary of a Chinese-backed company.

Midland Meets Orient: Former Linn Energy business development manager Curtis Newstrom leads China’s energy investment arm in Blue Whale Energy.

Blue Whale Energy North America—the parent of Moss Creek and itself a subsidiary of Beijing-headquartered energy investment firm Blue Whale Energy Ltd.—paid $1.084 billion for 78,000 net acres and 6,000 boe/d in Howard and Borden counties.

Blue Whale is led by Curtis Newstrom, the former business development master at Linn Energy. The company is the U.S. arm of Yantai Xinchao Industry Co. Ltd., a public conglomerate investment holding company traded on the Shanghai Stock Exchange.

The company is looking to make its mark in U.S. oil and gas, according to Newstrom.

“Yantai Xinchao is currently forming into an energy company, with plans to grow into a fairly large energy company with assets in the U.S. and Canada,” Newstrom told Oil and Gas Investor. “We plan to bolt onto our existing position or get into new basins.”

Blue Whale intends to represent other Chinese investment firms with eyes on American hydcrocarbons.

The Tall City portion of the deal garnered $803 million for 71,000 net acres and 3,750 boe/d.

Mike Oestmann, Tall City CEO and co-founder, said when he co-founded the company in 2012, “we believed in the opportunity the Permian Basin had to offer our team and investors…We anticipate that our active drilling program will be maintained despite the market’s recent downturn.”

Analysts at Tudor, Pickering, Holt & Co. said, based on limited info at its disposal, the Tall City sale implies $17,000 to $18,000 per acre undeveloped in Howard after deducting an estimated $170 million PDP value. “We assume the acreage is split 50/50 between Howard and Borden counties, and ascribed only $500/acre to TPHe lower quality and less de-risked Borden.

Though below the TPH estimated $25,000-per-acre mark set by Diamondback’s Howard County deal, the transaction highlights continued investor interest in this emerging part of basin.”

RBC Richardson Barr was advisor to Tall City, a Denham Capital-sponsored company. Bracewell & Giuliani was legal counsel. Plymouth is led by S. Todd Gibson and is backed by Arc­Light Capital Partners.

In October, Yantai Xinchao Industry Co. Ltd. said in a filing with the Shanghai Stock Exchange that it had a letter of intent to pay cash to Tall City and Plymouth for their related interests in Howard and Borden counties.

The acquisition gained the approval of the Committee on Foreign Investment in the U.S. (CFIUS), Yantai said in an announcement. The approval by the committee is an important hurdle, as many large-scale deals have fallen through for Chinese firms, largely due to national security concerns.

In 2005, the China National Offshore Oil Co. (CNOOC) dropped a proposed $18 billion acquisition of Unocal Oil Co. partly due to concerns about an impending CFIUS investigation.

In addition to the Moss Creek deal, Blue Whale closed a transaction in April 2015 with Juno Energy II, a private company, for $315 million on behalf of Surge Energy America LLC. These assets consist of approximately 2,500 boe/d and over 7,100 net acres in Crosby County, Texas, on the northern edge of the Permian Basin.

The Surge Energy transaction combined with the Moss Creek transaction brings Blue Whale’s total acquisitions for 2015 to US$1.4 billion and 85,000 net acres in the Permian Basin.

Stay or Go? Third-Quarter Prognostications

A&D aficionados know that even after all the number crunching, earnings calls and whispers from insiders, navigating the way ahead for deals might as well be done with an astrologer’s astrolabe. Industry watchers at large financial firms variously foresee a run up of activity—or more of the same. Some predict more bankruptcies; others don’t see it happening.

Third-quarter 2015 transactions in the oil and gas sector were powered by midstream megadeals. The upstream sector also saw a rebound with deals in the Permian, Eagle Ford and Utica/Marcellus, PwC reported.

Perhaps one certainty as 2016 approaches is that companies will aggressively protect their balance sheets in the coming year. Increasingly, E&Ps are weighing their asset positions and considering a question best posed by punk rock band The Clash: “Should I stay or should I go?”

In the upstream segment, deal volume was up 50% from the second quarter of 2015. Upstream deals in the third quarter totaled 27 transactions worth $8.8 billion. However, values were still 36% lower than the same period in 2014, said Doug Meier, PwC’s U.S. oil and gas sector deals leader. The most active shale plays during the third quarter of 2015 held no surprises. The Permian, Eagle Ford, Utica and Marcellus led the way with deals of $50 million or more.

But midstream did the heavy lifting in the quarter. Fourteen midstream transactions accounted for 70%—or $63.5 billion—of overall deal value, Meier told Oil and Gas Investor.

Deloitte Consulting LP said the industry’s “wait and see” mode would give way to a ramp-up in deals by year-end 2015. Steve Crower, director of the oil and gas team at SDR Ventures, predicts M&A activity will remain flat for now. Companies will continue slimming their portfolios through noncore asset sales, he said.

While companies typically hold on to their noncore assets, in a downcycle “everyone is chopping off their arms to stay alive,” Crower said.

E&Ps have taken a significant number of impairments and write-offs, said Seenu Akunuri, PwC U.S. oil and gas valuation practice leader. Case in point: Encana Corp., which is carefully watching its debt. In August, the Calgary, Alberta-based company said it would jettison its Haynesville Shale natural gas assets for $800 million.

The Haynesville has “always been marginal stuff and nobody needs money more than Encana,” said Crower.

In addition to its sale of 112,000 net acres in Louisiana, Encana said Oct. 8 it would sell its Denver-Julesburg (D-J) Basin assets for $900 million. Proceeds will be used to pay down debt. Encana planned to spend more than 80% of its capital on the company’s most strategic U.S. and Canadian assets: the Permian, Eagle Ford, Duvernay and Montney.

Resolute Energy Corp. also recently decided it would part with its Powder River Basin assets in Wyoming for $55 million. The deal followed the May sale of Midland Basin assets in Texas for $42 million.

Akunuri said oil and gas company valuations continue to be depressed as executives realize oil prices may stay at $40 to $60 longer than expected.

“We expect deal activity to pick up over the next 12 months as the market will see companies with free cash flow and strong balance sheets acquire assets and businesses from motivated sellers,” he said.

-Emily Moser and Darren Barbee, Hart Energy

Resolute Exits Midland, Favors Delaware

Taking a swipe at its massive debt, Denver-based Resolute Energy Corp. has agreed to sell its Gardendale assets in the Midland Basin to an undisclosed buyer for $177.5 million. Gardendale production made up about 12% of its second-quarter 2015 volumes.

The assets include 4,700 gross (4,600 net) acres in Midland and Ector counties, Texas. The company holds about 98% working interest in the property, which is HBP by vertical wells. Production during second-quarter 2015 was 1,649 boe/d.

The acreage includes resource potential in the Middle and Lower Spraberry and Wolfcamp B formations. Resolute has successfully drilled three horizontal Wolfcamp B wells on the Gardendale property. The company’s Midland wells averaged 30-day initial production rates of 536 boe/d, with 81% oil.

Additional potential exists on the property in the Wolfcamp A, C and D (Cline), Atoka and Clearfork formations, according to the company.

Proceeds will initially be used to take a chunk out of Resolute’s debt, which totaled about $740 million at the end of third-quarter 2015. In the long term, Resolute plans to use the funds for development activity, including its recently greenlit, four-well Wolfcamp program in Reeves County, Texas.

However, the balance sheet remains a “starkly present issue,” said John Freeman, managing director at Raymond James, in a Nov. 10 report. “Asset liquidation remains the clearest path for capital structure repair going forward.”

Petrie Partners LLC and BMO Capital Markets advised Resolute. The transaction, which was expected to close by Dec. 22, has an effective date of Sept. 1.

Including the Gardendale sale, the company has sold almost $275 million of properties in 2015.

In May, the company closed the sale of noncore assets in the Midland Basin in Howard County, Texas, for about $42 million. By October, it had closed another sale of a Powder River Basin field for $55 million.

“We believe these transactions have positioned the company to accelerate development of the attractive opportunities in our property base,” said Nicholas J. Sutton, Resolute chairman and CEO, in a statement. Resolute will continue to work on a “number of other strategic initiatives,” including the potential sale of its midstream infrastructure assets in Reeves County, Sutton said.

Oxy Exits Bakken To Build Up Permian

Occidental Petroleum Corp. made it official—it’s not the Bakken, it’s the company. Oxy confirmed that it will exit the Williston Basin after selling its assets for $600 million.

Instead, the company will regroup in the Permian Basin, where a large inventory of development locations awaits. The locations are economic at oil prices of less than $60 per barrel, the company said.

“We just can’t see a situation where we would invest in it, given what we have in the Permian,” said Stephen I. Chazen, president and CEO, in an Oct. 28 earnings call. “So it’s really a statement that says, okay, we just don’t see how it competes for capital inside the company in any reasonable price scenario that we can come up with.”

In essence, Oxy decided its Bakken holdings were noncore assets. Oxy had scaled back spending and said because of the nature of unconventional assets, annualized production declined about 25% between the second and third quarters of 2015.

Chazen said that the Bakken always generated negative cash flow or—at best—neutral cash flow.

“This $600 million, we could run four rigs in the Permian Basin for a year with this money, or five, somewhere in that range, and generate more production than we would get out of the Bakken with the $600 million box.”

The company’s Williston Basin average production fell by 4 Mboe/d to 17 Mboe/d compared to third-quarter 2014.

Chazen said Oxy’s divestiture goes along with a strategic decision to reduce investments in the Middle East and North Africa. While the Bakken assets might have fetched a better price at a different time, Chazen said by the time the price went up production might be 8 Mbbl/d. Operating expenses were also high in the region.

“We believe we received a fair price given the prospects for it under our management,” he said.

Until the Oxy sale, A&D activity in the Bakken had been barren through August, with only one E&P deal crossing the $20 million value line.

Fidelity Unwinds Portfolio In Multiple Basins

After starts and stops in the prolonged sale of Fidelity Exploration & Production Co., parent MDU Resources Group Inc. said Nov. 3 that it had secured agreements to divest nearly all of the company’s assets. Fidelity, an indirect subsidiary of MDU, holds assets in the Bakken Shale, Paradox Basin, Powder River Basin, Texas and Louisiana.

MDU said it closed on one property in October and had four additional purchase and sale agreements representing more than 90% of total year-to-date production as of Sept. 30. The sale proceeds and tax benefits total $450 million.

Buyers were not disclosed. The funds will primarily be used to repay debt, MDU said.

With the exception of one remaining “small property” that continues to be marketed, the deals effectively end Denver-based Fidelity’s 85-year history. The company at one time produced oil and natural gas in the Rocky Mountain, Midcontinent and Gulf States regions.

“We are pleased to be nearly complete with the sale process for our oil and natural gas assets,” said David L. Goodin, president and CEO of MDU Resources. “The sale prices are in line with current and prospective market conditions, and exiting the exploration and production business will allow us to focus more fully on our remaining businesses.”

In January, MDU said it had delayed plans to market Fidelity until commodity prices rebounded. MDU said it was spending about $100 million in capex on Fidelity’s operations. But by the end of the second quarter of 2015, it was actively seeking a buyer.

Devon Stacks Up

In Devon Energy Corp.’s most significant transactions of the year, the company had all its gears turning as it engineered two deals in the Anadarko and Powder River basins totaling $2.5 billion.

Devon said Dec. 7 that it agreed to buy 80,000 net surface acres with up to 10 prospective zones in the Anadarko’s Stack play from privately held Felix Energy in a transaction the company said adds another core play to its portfolio. Devon also agreed to purchase 253,000 net acres in the Powder River for $600 million from an undisclosed buyer. Felix is an EnCap Investments portfolio company.

In a related $1.55 billion deal, Devon’s spinoff midstream company EnLink Midstream Partners LP said it would buy Tall Oak Midstream in the core of the Oklahoma Stack. The vast majority of the Felix acreage position is dedicated to that midstream acreage.

Dave Hager, Devon president and CEO, said the three deals highlight the lucrative relationship between Devon and EnLink. Devon owns about $3 billion worth of EnLink and anticipates distributions of $300 million from the MLP.

“We leveraged the midstream relationship to secure the Felix transaction,” Hager said. “The EnLink relationship gave us a strategic advantage in this transaction. We would not have been able to place the value on Felix that we did unless EnLink controlled the midstream.”

The same was true of EnLink’s Tall Oak acquisition. “Knowing that Devon controlled the upstream assets and pace of development created differentiating value” for the MLP, Hager said.

While the deal adds the potential for game-changing resources, analysts were cautious about the deal.

Bob Brackett, senior analyst with Bernstein Research, said both assets make sense from an operations point of view. Both are located in basins where Devon is a major operator and knows the geology, he said.

The wells purchased in the Powder River Basin appear to be legacy RKI Exploration & Production LLC, Brackett said. In August, RKI sold its Permian Basin leasehold to WPX Energy Inc. for $2.75 billion.

Brackett said he was “somewhat surprised” at the price of the Stack deal. “Our concern is that the stacked pay potential is clear, but the level of inventory Devon already has is significant,” he said. “The time to wait to monetize the various zones seems sufficiently long that the time value of money of those locations is significantly diminished.”

David Kistler, analyst with Simmons & Co. International, questioned the use of equity and the healthy premium paid for the Stack assets “without a clear line of sight to a recovery in oil prices.”

While the acquisition adds another core similar to the Eagle Ford, Wells Fargo Securities LLC was equally edgy about the deal. “We think the stock likely comes under pressure,” said David Tameron, senior analyst with Wells Fargo. Indeed, in early trading Dec. 7, Devon shares fell roughly 7%.

“Levering up in this environment will not be well-received,” he said. The “Felix price tag looks rich and some conversations last week regarding this potential transaction had investors questioning what we don’t know about their Permian position.”

Hager said the acquisitions are immediately accretive.

“At strip pricing, these transactions boost our cash per share in 2016 by a few percentage points and that increases to above 10% in 2017 and beyond,” he said. “Our cash margin also expands by 5% pro forma for the transaction.”

Devon will pay for its Powder River and Stack tabs using $1.5 billion of cash on hand and another $1.35 billion of equity issued to the sellers.

Hager said that the Felix acreage was long at the top of its list for a deal.

“In our opinion, this is the best emerging development play in North America that combines some of the best attributes of our Eagle Ford and Delaware positions,” he said.

A&D activity in 2015 sank to its lowest level since 2009. With capital flowing into the sector and participation in broad sales processes at record levels, activity was depressed by limited asset supply.

In theory, 2015 should have been a banner year for A&D activity—falling prices would depress asset values, forcing operators to part with core properties in order to avoid defaulting on their loans. While some companies have sold noncore assets to generate cash, the expected wave of distressed assets is still yet to be seen. Companies will not part with core assets until prices recover or their financial position forces them to do so.

This spring will be the fourth time that banks have redetermined borrowing bases since oil prices fell precipitously in the summer of 2014. Until now, the impact of redeterminations has been relatively benign, delaying the expected wave of asset sales.

We consider there to be four major factors that have buoyed asset values and prolonged distressed assets reaching the market.

First, halting development does not have an immediate impact on production. Typically, it takes several months to bring a well online after it is completed and additional time to see any meaningful decline. Producers were surprisingly fast to react to falling oil prices; the U.S. rig count declined from 1,925 in November 2014 to below 900 in May 2015, but it took an additional six months for production to flatten. While the behaviour of total U.S. production is influenced by many factors, the delay in production decline due to suspension of development can be extrapolated to individual producers as well. As a result, the first several borrowing base redeterminations for many companies saw flat to increasing levels of production.

Second, over the last several years, banks have relaxed the price decks they use to determine borrowing bases in relation to future strip prices. Historically, price decks have averaged between 75% and 80% of forward strip prices. Since 2009, the difference between forward strip prices and bank price decks has narrowed. In 2014 and 2015, bank price decks were between 90% and 98% of the strip. This has increased borrowing base valuations relative to strip prices.

Third, futures prices have shifted from backwardation to contango. Since bank price decks are based on strip prices, the increase in futures prices increases the value of production forecasted in those years. In August 2014, the forward strip price was normally backwardated and by January 2015 the forward strip was increasing by $6 in the first year and 2020 prices were above $70 per barrel. This increase in futures prices works to counteract the drop in current oil prices.

Finally, in 2014, many companies hedged a large portion of their production through 2015 and a smaller portion of their production through 2016. This locked them into prices in the $80 to $90 range for any oil produced during those years. When taken in conjunction with increasing futures prices, operators’ assets are being valued with a price deck that does not include the current price of oil.

The combined effect of these factors has insulated the value of assets from the full magnitude of the drop in oil prices and resulted in many borrowing bases being reaffirmed at or very near previous levels. Since banks typically lend at an advance rate of 65% of asset value, relatively few assets have reached a point of insolvency with their reserve based loan. Until they reach that point, lenders have a strong possibility that they will be able to recoup the entirety of their principal and, until that time, they can continue to collect interest payments.

As hedges roll off and futures prices decrease, the impact of low prices will continue to push producers closer to insolvency, forcing banks to take action. However, as we have seen so far, the road to asset sales is long and slow.

—Grant Butkus, Senior Vice President, Head of A&D, Macquarie Capital, (713) 651-4230, grant.butkus@macquarie.com