Independent upstream operators want the right deal for the right price in precisely the right place, said Bobby Tudor, chairman and chief executive of Tudor Pickering Holt & Co. at the Houston CPA Society's 2013 Energy Conference, held in late August.

Increasingly, upstream companies are staying tightfisted as they feel the pressure to turn around cash flows that will have some seeing billions bleed out in the next year or two.

While the energy industry has long had a voracious appetite for capital, the mismatch between cash flow and the need for capital is taking its toll, Tudor said.

“In the M&A business, there have clearly been pressures on returns,” Tudor said. Instead, independents are trying to turn the corner on negative free cash flows in the next couple of years. “There is more money going out the door than there is money coming in the door,” he said.

“M&A has slowed, and slowed fairly dramatically in the US,” he said. “People will still buy, but they will only buy if it's absolutely right on top of what they already have and it's cheap. Those two things are actually hard to come by.”

Under those parameters, it is unlikely companies will do a lot of deals.

“The days of EnCap Investments' aggressive investment in North America paying off are harder to come by today,” he said. EnCap, by funding new E&Ps, bought into unconventional resources when oil was roughly $65 or $70. That's paid off nicely, as oil has risen in price past $100, Tudor said.

“In many ways it's much harder now with WTI at $105, and acreage obviously going at much higher levels, to expect the same kind of returns going forward,” Tudor said.

The hunt for money goes on, but for the most part, companies have been loading up with debt. They are eyeing broader financing and evaluating “every alternative possible,” Tudor said. That includes public and private equity, private bonds, bank loans, second-lien financing, preferred stock, convertible securities, joint ventures and minority interest sales.

“We've got this period where balance sheets have slowly got more and more stressed,” Tudor said. “Public market investors don't want their companies to issue equity, yet there are huge capital requirements facing the companies, particularly the upstream companies in the unconventional game. And all of a sudden they have a lot more opportunity than they do capital.”

Some of the largest independent upstream companies are facing tremendous free-cash-flow negatives. Tudor said about 75% of the upstream “universe” is outspending free cash flow.

“Petrobras is outspending free cash flows to the tune of $22 billion in 2014,” Tudor said. “Even a very big, substantial company like ConocoPhillips is outspending free cash flow by $4 billion in 2014.”

But private equity and joint ventures have continued to infuse capital. “There's a ton of dry powder still sitting around in the energy private-equity world,” he said.

Joint ventures loaded with foreign money will also continue to push capital into the industry.

“These days, about two-thirds of the M&A business is selling assets,” Tudor said. But, “if you can't attract some combination of Asian buyers and private equity to your data room, there's a fair chance you're having a party that nobody's coming to.”

Tudor said he has no doubt the Chinese government has directed companies to get smarter about unconventional resources and develop expertise.

Still, joint ventures are likely to be reserved for large companies.

“If you're a small independent that needs $50 million to help you do something, you're highly unlikely to be attractive to foreign joint-venture capital,” he said.

Going forward, Tudor said, 2008-2010 shale investments should become cash-flow positive in 2014-2015. Interest will continue in US assets among international buyers and partners, who will prefer oils and liquids to gas. And capital will continue to move toward the midstream.

“What's a little new is that you now have a handful of dedicated (private-equity) funds, organized into midstream and infrastructure, that has flowed into the infrastructure space in the last year or two,” he said. “The problem is that they are competing with MLPs who can raise equity at a very low cost of capital.”

—Darren Barbee

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