Getting the Band Back Together

The Eagles said during their first reunion concert a few years ago, after being off the road for 20 some years, "We never broke up; we just took a vacation." Thomas A. Petrie and Jon C. Hughes might say the same.

Partners in energy investment banking for 26 years, they and some colleagues have banded together in a new iteration as Petrie Partners LP in Denver. This follows their recent five-year stint at Bank of America Merrill Lynch, where Petrie was vice chairman and Hughes was a managing director in the bank's energy group. In 2006, Hughes was the principal negotiator when Merrill Lynch acquired Petrie Parkman & Co., the boutique they had cofounded in 1989.

If anyone can name drop in the M&A&D world, it is this pair. Petrie has been an active advisor on more than $200 billion of energy transactions over a career that spans four decades, and has shared his insights with our readers many times. One of the former Petrie Parkman's most noteworthy deals was advising the U.S. Department of Energy on its sale of the Elk Hills Naval Petroleum Reserve in California to Occidental Petroleum Corp. in 1998 for $3.7 billion—the largest U.S. privatization and one of the largest divestitures ever in the oil industry at that time.

Tom Petrie, who has banded together with past colleagues to form Petrie Partners LP, says they want to help private capital sources and public companies navigate today’s challenging waters.

Prior to forming Petrie Parkman, he was a managing director and award-winning senior oil analyst for First Boston Corp. He received his B.S. from the United States Military Academy, an MBA from Boston University and an Honorary Doctorate from the Colorado School of Mines.

Noteworthy transactions managed by University of Texas petroleum engineer Hughes include the merger of Western Gas Resources Inc. into Anadarko Petroleum Corp., Tom Brown Inc. into Encana Corp., and the first iteration of Magnum Hunter Resources Corp. into Cimarex Energy Corp. More recently, on the asset side, he advised on the sales of Anschutz's Bakken and Utica shale positions to Oxy and Chesapeake Energy Corp., respectively.

This time around, Petrie Partners will be more streamlined, with a focus on strategic advisory work, mergers, acquisitions and divestitures and private placements, versus public offerings, equity research, or sales and trading.

And as he plans for the future and looks back on his 41 years in the business, Petrie has been writing a book about his wide-ranging experiences in the oil and gas sector. It should appear sometime in spring 2013.

Wanting to know about their M&A outlook, Oil and Gas Investor met with Petrie and Hughes at their temporary offices in Denver, a unique castle-like building that used to be a gentleman's gambling club—the humor of which is not lost on these two solid investment bankers.

Investor Why not rest on your laurels; why jump back into the fray?

Petrie It's a delight to have it back together and be with people you know and trust who've been through the cycles. The genesis of the idea was really not mine; it was Jon's and my other partners'. I was flattered, but it is not so much about me as it is about the fact that key elements of the team wanted to come back together. I will be chairman and Jon the CEO. He will really run this.

Hughes I personally am more comfortable in a client-focused boutique situation. When I left Bank of America in March 2011, I started thinking about this. We had carved out a nice niche at Petrie Parkman, and we had an individualized approach to serving our clients. We had built a reputation of trust.

I think we did 200-plus transactions—some $85 billion in M&A&D alone—during our time at Petrie Parkman. When we sold it to Merrill Lynch in 2006, there was a strong strategic basis for the deal, but it turned out that Merrill had some issues. We met a lot of good people at Bank of America Merrill Lynch, but in the end, we feel we are more boutique-oriented. It was an attractive thing for Tom to come back, as he has an irreplaceable wealth of knowledge and cycle-tested experience.

Investor What kinds of projects do you have under way?

Hughes We've helped complete a few divestments and we represented the special committee of the Venoco Inc. board on CEO Tim Marquez' transaction to take it private. (Editor's note: this go-private deal closed October 3.) We advised on a multi-hundred-million-dollar deal for a large public company, but the details of that transaction were not publicly disclosed.

Jon C. Hughes of newly formed Petrie Partners notes that there is increased capital intensity in the industry now, which argues for larger, better-financed platforms to pursue today’s development opportunities.

Investor Do you foresee more companies wanting to go private or was this a one-off?

Petrie Going private transactions tend to take a long time and thus are generally few in number due to their complexity. However, Jon and I both expect another wave of M&A over the next several years.

Investor Why is that?

Petrie There are several drivers now identifiable. For one, there is abundant liquidity with likely acquirors. Majors and large-cap independents have over $100 billion of available cash on their balance sheets, have generally been late to build shale acreage holdings, and can always use new ways to grow organically. In addition, large private-equity firms are focused on investing in petroleum ventures and international players are becoming more comfortable with U.S. operations.

There is pent-up demand for transactions. Of the top 50 (E&P) companies, 13 were acquired between 2004 and 2006, or at a pace of one per quarter. Petrie Parkman advised on half of these transactions. Since then, the pace of acquisitions has slowed by 75% to only one per year.

Hughes There is increased capital intensity in the industry now, and this argues for larger, better-financed platforms to pursue today's development opportunities, with well costs now ranging from $8- to $12 million, and infrastructure costs accordingly upgraded as well. Oil and gas manufacturing is fast becoming a "big boy" game.

Also, there is a natural gas margin squeeze that is compressing liquidity for producers whose gas hedges are running off. And finally, we think there have emerged multiple, intriguing logical combinations of independent companies.

Investor What kind of advice do these companies need?

Petrie We are particularly well-positioned to help managements with their strategic thinking, whether they are private or public. We are able to maintain the highest degree of confidentiality. At Petrie Parkman, our clients included the DOE and Saudi Arabia, so we understand the sensitivities of those kinds of players. We can see the need for objective inputs on strategic advisory matters. There can be inherent challenges in strategic thinking if managements have too many other irons in the fire running their day-to-day businesses.

Hughes We're not going to be revenue driven quarter to quarter. We're doing this because we love the business and working with clients we enjoy and respect. We intend to keep a reasonably small footprint.

Investor Tom, tell us about your new book.

Petrie I've been working on it in my spare time for the last year or so and it's been a lot of fun—I find the more I write, the more I recollect. The idea was in my mind two decades ago. I feel blessed to have entered this business in

1971, which was a tumultuous time. You had OPEC, price controls and bad regulations contributing to a tripling of oil prices. That set up an amazing decade of the 1980s. Mark-to-market expectations triggered high value expectations and suddenly, from 1981 to 1985, you saw the greatest consolidation period ever. You saw the disappearance of Marathon into U.S. Steel, Conoco into DuPont, and so on.

That contraction set up a remarkable regeneration. In 1979 we had 62 institutionally suitable public oil and gas companies and they became only 19 by 1987. That was the year we took Union Texas Petroleum public (UTP was later acquired by Atlantic Richfield).

The industry built back up to 74 independent producers and we helped regenerate that. There were a lot of M&A transactions in the 1990s. Then we saw petro-merger mania Phase 2, starting with our defense of Barrett Resources. Some 22 companies were consolidated at the time and we were involved in half of those deals. In my book, I'm going to lay out some of the lessons learned from those growth and consolidation cycles.

Investor What about today; what are your concerns or observations now?

Petrie There are big energy challenges ahead. The oil and gas business is so strategic to the country's future. Energy is a big, big part of our economy…We can't get from here to there without fossil fuels. We want to help private capital sources and public companies navigate those waters. I have a lot of faith the industry will come out the other side in strong shape.

Investor What kind of issues are your clients mentioning to you?

Hughes They are talking about the marriage of horizontal drilling and fracturing and the implications and costs of the technology. A lot of companies we work with have ample opportunities and they're interested in how to most efficiently develop them. Should they sell some assets, should they bring in a partner, or do an offering? How do they position themselves to go up the food chain? It's the smaller companies with specific geographic niches that are being acquired by larger companies.

Petrie Companies have to figure out how to drill enough to validate their acreage but not over-exploit it. As you move from validation to exploitation that's a different skill set, an exciting new dimension.

For the last 30 years we worked with a 10-year reserve life for natural gas. Today we can argue whether it's 50 years, 75 years or a 100. We now have forward planning and we're talking about what kind of role we will play in international markets.

Investor So you're on board with LNG exports?

Petrie Absolutely. The compelling reason we should do it is we have this 100-year reserve life but you've got to incentivize the capital to develop it in a timely manner. I think we have the ability to export 10% or 15%, maybe 20%, of our gas as a pressure-relief valve. We've got to provide price visibility to the drillers.

Hughes It's not an overstatement to say that energy issues significantly impact the balance of power in the world, financially and politically. It troubles me to export U.S. dollars to oil-producing countries that don't like us much; that capital ought to be spent in Texas or Ohio or in the Williston Basin, places where it will recirculate in our economy.

Petrie Harold Hamm (CEO of Continental Resources Inc.) has probably articulated the potential game-changing aspects of unconventional oil as well as anyone. Jon mentioned the Willis-ton: there is far more oil to be developed there. It's not just about the Bakken; it's the four benches in the Three Forks. We've got an accumulation there that's quite likely bigger than Prudhoe Bay and maybe even two to four times the size. We've got the ability to dial back our nation's dependence on imported oil. In this decade we can transform our trade position.

When economic historians look back at us, they'll see that the bulk of the job creation in the past five years has been in oil and gas. Trickle down does work when it's pursued properly. It ripples throughout the economy. Our ability to be in control of our destiny is better today than when I started in 1971. That makes me really energized.

Investor What role should government play in all this?

Petrie The role of government is still open for debate, but if you think of the priorities of the country, probably 80% of people say it'd be education, health care and energy. If we don't get energy right, we're not going to be able to afford the rest, so that makes energy the No. 1 priority. We've got the options to work with now and we couldn't say that a decade ago.

Hughes And as an industry we've got the right technology currently available; it's not 10 years out. We have the technology, we have the will and we have the capital. But we live in an era of empowered regulators, so as an industry we will probably sub-optimize relative to our potential.

Petrie We also have an energized anti-fossil-fuel industry that is fairly clever in using litigation and misleading media channels to create fear and raise doubts about the energy industry. Unfortunately, a lot of people can be persuaded with misinformation. The industry is doing better getting the facts out, but we cannot assume the battle is over.

Investor What's your outlook for a natural gas recovery?

Petrie Gas has a future. I'm optimistic gas will be in a more accommodating range of $5 to $6, but it does depend on improved overall economic growth. Gas into power is a big factor. We're actually ahead of expectations on lowering greenhouse-gas emissions and CO2 reduction. We're on track to be ahead of schedule by 2030.