The outlook for A&D activity in 2012 has positive drivers to equal the previous year, give or take, but the story will play out as a tale of two commodities.

"Oil is hot, gas is not," sums up Harrison Williams, executive vice president of Albrecht & Associates Inc., a Houston-based asset marketing firm. "The desire to get out of gas and into oil is a major driver of the market."

Last year concluded with $67.9 billion in U.S. oil and gas assets changing hands in 214 deals, as per Hart Energy's A&D transaction database, and could have easily been higher if supply had kept pace with demand. That figure includes $33.7 billion in corporate M&A, $20.8 billion of assets and acreage and $12.1 billion in joint ventures.

Harrison Williams, executive vice president of Albrecht & Associates Inc., says, “The desire to get out of gas and into oil is a major driver of the market.”

Commodity prices are always the first filter influencing asset availability, and the extreme bifurcation between oil and natural gas dominates the discussion at present. Heretofore low gas price—hovering around $2.50 at press time and a whopping 42:1 gas-to-oil ratio—has locked up the conventional-gas asset marketplace and scuttled big drilling projects in dry-gas resource plays.

"At these gas prices very few of the gas plays work. And at these oil prices, all of the oil plays work," says Williams. "Everybody wants oil."

The sustained high oil price—hovering around $100 per barrel and contrasted with the flailing price of natural gas—is clearly the No. 1 factor driving A&D activity.

"The projects we see selling are primarily oil-based and high-liquids projects," says Matt Meagher, president of Denver-based Meagher Energy Advisors. "Right now, it feels like oil in the U.S. is the only game in town."

Says Matt Meagher, president of Meagher Energy Advisors, “Right now, it feels like oil in the U.S. is the only game in town.”

The gas dilemma

Many companies are hesitant to even put dry-gas projects into a weak marketplace due to the effect that price has on driving down present value, observes Meagher. Consider, too, that low gas prices have effectively stripped proved undeveloped (PUD) gas locations of all value. Thus, sellers feel they are giving away acreage that used to be PUDs, and are not selling dry-gas assets until they absolutely have to.

"Sellers are not selling dry-gas projects," he says. "Oil sells, while gas sits on the shelf for awhile."

Art Ensley, managing director of Riviera-Ensley Energy Advisors in Houston, agrees. "PUDs have been hammered because no one wants to drill dry gas wells at this price point. For dry-gas PUDs to have any current market value, they can't be too capital intensive in the near term. PUDs must have longevity and minimal drilling obligations in the near term, otherwise there's not much value there."

Williams adds, "Most gas PUDs that we see are very low rate of return, and won't get paid for. Thus most gas packages that will be sold this year will be PDP (proved developed producing) dominated." On the other hand, "we are selling oil-dominated packages where two-thirds of the value of the package may be attributable to PUDs. This makes the metrics of the two packages, on either a barrel of oil equivalent or an Mcfe (thousand cubic feet equivalent) of gas, misleading."

“PUDs must have longevity and minimal drilling obligations in the near term, otherwise there’s not much value there,” says Art Ensley, managing director of Riviera-Ensley Energy Advisors.

The wait-and-see effect has locked up gas assets for several quarters as gas sellers anticipate better days. A tepid winter, however, has dashed any hopes of upside with a near-term recovery in gas prices. When that realization comes to fruition, properties will come to market, Williams believes.

"A $100-million proved developed producing property has upside only to price," he says. "That $100 million deployed into one of the oiler trends has a lot of upside in terms of drilling. At some point that asset shift occurs."

That shift may be in motion now, as companies are closing their year-end accounting and are realizing the PV10 value of their portfolio at current market prices.

Ensley says end-of-year housekeeping has already resulted in new deals in his shop—with a twist. "We're seeing sellers trying to blend more attractive liquids-rich properties with dry-gas properties—where margins aren't as shiny—to improve market appeal." High-condensate gas properties still command a premium over dry gas due to the uptick for liquids.

Squeezed cash flows and spring bank redeterminations could squeeze gassy assets to market as well. However, the advisors point to 2009 when that trend was anticipated and barely materialized.

But who wants to buy gas? Private equity, for one.

"We are seeing a bit more competition for gas properties with new capital sources being put together to chase conventional gas," says Ensley. These buyers believe they are buying gas at the low-side of the market, a positive sign that some believe there is optimism for gas prices. "It's giving us some competition in that arena where, even a few months ago, there was little or no competition. It's just a matter of whether there are assets to chase."

Meagher confirms, "There is a market for conventional assets. Private equity is the most active buyer for PDP right now."

Driven by shale

Adrian Goodisman, managing director and co-head, U.S., for Scotia Waterous in Houston, points to international oil and gas companies as continued major players in the U.S. M&A space. Driven by a desire to get access to both gas and oil shales onshore U.S., large European and Asian companies have been active acquirers over the last three years.

With a couple of Asian transactions pending, Adrian Goodisman, managing director and cohead, U.S., for Scotia Waterous in Houston, says there is Asian interest in the sub-$1-billion market.

"We're seeing more interest from a variety of folk, but we're seeing more interest by some Asian companies that traditionally haven't spent time looking at the U.S." With a couple of Asian transactions pending, he notes an Asian interest in the sub-$1-billion market.

Recent corporate transactions have been and will continue to be driven by shale—an entry point for second-movers in resource plays.

"For some companies it may be easier to buy the corporation to capture the resource versus trying to do a straight asset transaction," says Goodisman.

Others are seeking a team to operate in the shales, like BHP Billiton, which bought the skilled Petrohawk Energy team after having acquired Fayetteville shale assets from Chesapeake Energy Corp. previously, and which Scotia Waterous advised BHP on both transactions. "We're seeing interest from companies needing a team to operate," says Goodisman, "so they're looking to corporate transactions."

Gas-weighted, shale-focused companies in particular may become targets as their stock prices drop to a point in which they trade at less than their net asset value. "In effect, they become cheap buys," says Goodisman.

But oil-weighted companies, too, will experience suitors simply for access to oil assets. That was the case with Statoil ASA's move on Bakken-focused Brigham Exploration Co., paying a 36% premium for the privilege.

Goodisman expects a steady flow of corporate deals through 2012, but notes the M&A market is still largely driven by asset transactions.

Assets from JVs?

While pundits continue to anticipate the demise of billion-dollar joint ventures, the popular shale-development funding strategy continues to pop in defiance. Last year witnessed $12.3 billion in JV announcements, according to Hart Energy's A&D Transaction database, with the fourth quarter ending with a strong $4.4 billion.

"You'll see more joint ventures and outright sales because they are easier to do than corporate M&A," Goodisman explains. Companies with large shale acreage holdings that have been reticent to bring in a capital partner may reconsider as cash flow and stock prices trend down, he suggests. "They are then a bit more capital constrained and won't want to put more leverage on the company or issue equity."

Observers anticipate the opportunity for super-sized joint ventures to fade as shale plays with immense scope are absorbed, to result in a robust marketplace for medium-sized partnerships. Emerging resource plays with vast areal extent such as the Utica shale and Mississippian play continue to feed the machine, though, with other hopeful names—Tuscaloosa Marine shale, horizontal Wolfcamp—on the horizon.

Still, Ensley views the shift as imminent. "A lot of these big acreage plays are slowing."

Additionally, he anticipates the existing high-dollar shale joint ventures have a time mechanism built in, to directly affect the asset marketplace as the players get itchy to see returns on investment.

"As soon as they start to see results, they are going to want exit strategies in the near term, because they plowed in so much money in a short time frame. It's on our radar to see if any assets start to peel out as a result of those joint ventures. Therefore, we believe asset sales are set to overtake land grabs and joint ventures over the next couple of years."

Open season

Similar to gas at the opposite spectrum, oil assets have been coveted and tightly held. The trend up in crude pricing has made sellers hopeful and buyers cautious. Ensley notes a growing confidence in buyers and sellers that the oil price will stay firm within a narrow band, shrinking differences of expectations.

"Every time oil has hit the $100 window in the past, buyers have been reluctant to pay that price—but they're getting used to it." Sellers, on the other hand, have banked a few months of revenue checks and are warming to testing the market for a sale while the market remains hot.

"There's more calmness in the price environment for oil," he says. "We're seeing more assets come to market with steady oil prices."

One reason the A&D marketplace is primed to go is the huge pool of capital available. Debt and equity markets are wide open, and private capital is abundant and seeking opportunities.

"Capital has not been an issue whatsoever," Meagher affirms. "There are plenty of well-funded companies" in the buying arena.

Although many gas-weighted companies are struggling with cash flow as they redirect portfolios to liquid-weighted assets, they are tapping the equities market for needed capital, versus adding debt.

"Acquiring out of cash flow is difficult even for large companies right now, but there is equity on the market and they are able to raise it."

Uncertainty will impact the deal market this year in unpredictable ways—uncertainty over the U.S. economy and upcoming election, uncertainty over Europe's financial situation, and uncertainty over geopolitical instability such as exists in Iran and the rest of the Middle East.

Albrecht's Williams anticipates assets will come to market as the year progresses due to an expectation of increases in capital gains taxes. With the Bush tax cuts set to expire year-end and the country deep in debt, Congress is more likely to not act and allow taxes to revert to pre-Bush era rates. "Without a Republican sweep, I think it's likely that taxes will increase." "It is going to be an aggressive market, skewed by huge transactions that are hard to predict," he says. The net effect may be a stirred pot of assets with plenty of capital to flavor it. "Our deal flow is steadily picking up," Ensley says. Meagher, too, anticipates plenty of action. "Based on what we're seeing early this year, our activity level will be twice what it was last year in 2011—and that was a good year."

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