Following a virtually dormant eight-month period beginning in November 2008, A&D activity is reviving. But despite some capital-market recovery and relatively strong oil pricing, most experts do not expect activity to improve dramatically until natural gas prices are again aligned with oil at historical levels. In other words, the single biggest driver in A&D activity is commodity price, followed closely by capital availability.

Pricing contango. Oil prices have stabilized at around $65 to $75 per barrel since June, which is a solid price environment in which to sell properties. On the other hand, gas prices have been floating in the range of $2 to $4 per thousand cubic feet (Mcf) since January and have only recently flirted with $5 per Mcf. Fortunately, as of this writing, the December Nymex futures price is back above $5 and doesn’t fall below this amount into the future.

Unfortunately, most buyers and sellers have remained cautious due to concerns about high gas-storage levels, eroding gas demand, reports of new high-rate shale-gas wells coming online, and increased government intervention. So, even when gas futures prices floated around $4 per Mcf, sellers remained wary of committing properties to sale, fearing that prices could easily drop into the $2 range by the time their assets actually reached market.

To confuse the market even further, sellers have been confronted for some time with an inverted—or contango—future price curve for both oil and gas. This is a major deterrent to any producer considering asset sales: based upon the futures curve, with gas pegged at $6 per Mcf in only a year’s time, why not wait?

Misleading metrics. The most asked question received by The Oil & Gas Asset Clearinghouse is, What are the auction metrics so far in 2009? It appears to be a legitimate question, because auction always closes more transactions than any other process. However, caution must be used if averages are applied to determine the metrics, because averages are, of course, made up of high and low prices and everything in between.

For example, if the average results of a single auction were $50,000 per net barrel of oil equivalent per day, that does not mean every potential seller should expect to receive the same price. Now, more than ever, huge variances occur in sale metrics based on the characteristics of the asset and timing of the sale.

Making a fair comparison requires critical information about the assets comprising the average being quoted. Only then can one make a fair comparison of whether the asset for sale fits into the same mold as the quoted averages.

In two third-quarter 2009 auctions, assets were sold in 12 states by oil and gas producers. Some were working interests and others were royalty interests. Many featured dozens of wells and others a single well, and remaining reserve life varied widely. Applying an average metric to a specific producing property without having in-depth knowledge about the assets making up the averages is a recipe for disaster, whether you are buying or selling.

Equivalencies decoupled. In addition to the attributes of the assets themselves, the simple calculation of the conversion from gas to oil has added to the confusion. Natural gas prices have completely decoupled from oil prices and the conversion ratios have made comparisons as difficult to decipher as hieroglyphics.

Forget the old 6:1 per Btu conversion, or the 10:1 price ratios that have been used for years. Since March 2008, gas versus oil prices are seeing conversion ratio differentials of 20:1 and 25:1! Simply looking at an average metric, where oil properties and gas properties are combined, will result in misleading information, if taken out of context.

Market evidence. The Clearinghouse’s auction results provide tangible evidence concerning what most observers already believe: Oil is more in favor than gas this year, receiving better than twice the average dollar per flowing barrel in auction. Royalties and overriding royalty interests are achieving better metrics than working interests, at greater than a 2:1 ratio.

Buyers are also willing to be more aggressive in buying proved developed producing reserves than during the high-commodity-price environment of early 2008. The general consensus is that buyers can push the present-value percentage a few points if they believe there is upside in the commodity prices or improved production.

Value can still be achieved for proved undeveloped (PUD) and proved developed nonproducing reserves—if they are economic at the current prices. Unless the buyer has definitive plans to drill PUD reserves relatively soon, they are being more heavily discounted than a year ago.

Forward curve. Vital signs for A&D are beginning to strengthen. Buyers seem to have confidence for now, with data rooms filling up for every available package. Companies that have been reluctant to discuss selling so far this year are warming to the idea, and more packages are becoming available.

Expect to see more buying opportunities as companies begin to believe both in the effects of a forecasted cold winter on gas storage and in the 2010 futures prices. Buyers already believe in improved prices, because they can lock them in with hedges as soon as they make an acquisition.

—Ron Barnes, senior vice president, The Oil & Gas Asset Clearinghouse (281-873-4600)