As the oil and gas industry comes to grips with a split personality in commodity prices and a flood of capital pouring into the space as a refuge in a volatile global economy, the E&P A&D marketplace is experiencing a tug of war between divergent drivers. Seeing the drama at the tip of the spear, four notable A&D advisors came together to discuss these trends at Hart Energy's 10th annual A&D Strategies and Opportunities Conference in Dallas recently.

Market slowdown

In spite of some $28 billion in deal value over 90 deals through August, transaction flow in 2011 has been "really quiet," Scott Richardson, principal with RBC Richardson Barr, observed. "Peel back a few of the big transactions, and 2011 looks a lot more like 2009 than 2010. We thought 2011 would have been busier."

The reason is simple, he said: most U.S. properties that might otherwise be for sale are natural gas, but valuations for dry gas are hovering in the range of $5,000 to $8,000 per daily thousand cubic feet of gas equivalent. If selling, "You're not going to market with dry-gas assets right now."

That statement comes with an exception, and a big one. Large public companies wanting to focus on liquids and fund their resource plays are pushing gas assets to market to avoid issuing equity while stock valuations remain low. Three to four large gas deals are in the market now, including Encana Corp.'s Barnett shale assets, which could bring $900 million or so.

Contrary to popular belief, a huge buyers' market exists for dry gas, he said. "Even if valuations are not at their peak, there is an incredible amount of demand." Gas deals command up to 40 signed confidentiality agreements and 30 data-room visits in his shop. The takers: "Sixty to seventy percent of participants are private equity. We see very little public interest in dry gas."

Commanding a 65% premium, BHP Billiton's acquisition of Petrohawk Energy Corp., an all-cash transaction, was unusual, he said, in that the purchase price ballparked Petrohawk's value at its high in 2008. Historically, M&A premiums range from 20% to 40%.

But rather than being a catalyst to more corporate M&A, Richardson views the deal as a damper by setting the premium bar so high. "Now that a precedent has been established, it's going to be hard to see future M&A unless it's a situation much like the Petrohawk situation."

Best metrics

Tudor, Pickering, Holt & Co. managing director Ward Polzin noted that oil assets, whether conventional or shale, are at the top of the heap because of desirable metrics. Sizeable shale-gas deals are also strong in the marketplace. Conventional gas brings up the rear, he said, but not as far behind as some may think.

Oil metrics are "the highest we've ever seen," Polzin said, and are on the rise. Proved reserves are trading for $15 to $20 per barrel of oil equivalent (BOE), with flowing BOE capturing $100,000 to $120,000 and higher. Some $6 billion per quarter is transacting in the shale-gas niche over the past couple of years, but one big deal per quarter on average is driving the numbers, mostly in the Marcellus shale.

And while hard-pressed for any respect, proved conventional gas metrics are holding up "quite well," Polzin believes, with a blended $1.50 to $2 per Mcfe overall. "It's been pretty consistent over the last year—not too bad considering the commodity-price environment. We're living in a $4 world, but getting the same metrics as in a $5 world."

Why the value prop? Master limited partnerships (MLPs) have dominated the conventional gas market of late, targeting low-decline, proved developed producing-heavy assets.

Dealing in shales

International oil companies that have completed shale transactions will be making size- able bolt-on acquisitions, predicted Bill Marko, managing director for Jefferies & Co. Inc. As evidence, with an additional $1.7 billion in shale acquisitions following its acquisition of XTO Energy, "ExxonMobil is doing things it would have never done" before adding the XTO team, he said. "You'll see other companies do that as they get up to speed with their first big acquisitions."

Evaluating shale metrics, the Eagle Ford offers the best single well and the best project economics globally, Marko declared. "The economics are superb. Companies tell us this is the No. 1 play in the world they want to get into."

Valuations reflect the demand. Acreage metrics in the best zones have rocketed up to $17,000 to $18,000—with Marathon Oil paying in excess of $20,000 for Hilcorp Co.'s assets—up from $5,000 just 18 months ago.

Yet Marko warned against giving too much credence to dollar-per-acre metrics, as the play is highly variable. The condensate window trades at the best values, as it is the most economic. "We've seen portions of deals where the allocation value is $55,000 per acre," he said. The jury is still out on the oily section, with relatively few wells drilled. The dry-gas region gets the least attention and valuation, trading for a few thousand per acre.

The Marcellus has come off of peak valuations at $14,000 per acre, he noted, which he attributes to sellers capitulating to the current pricing environment. "Everybody remembers the world record, but we're not there now."

But the vast size of the play, its operational successes and low finding and development costs—combined with proximity to half of the nation's gas markets—assure the Marcellus' continued value. "It's going to win no matter what the gas price is," Marko said.

What's next for the shales? Smaller, less-capitalized companies will continue reaching out to larger joint-venture partners, and new entrant appetite has not disappeared. "Some companies are still looking," he said. One area of note is Asian interest in Western Canadian gas. "You're going to see a lot of Asian deals in Canada to source supply for the liquefied natural gas plants now on the drawing board."

PDPs vs. PUDs

Harrison Williams, executive vice president for Albrecht & Associates Inc., in evaluating competition for asset packages high in PDP vs. packages with high proved undeveloped (PUD) reserves, determined that buyers carve out the valuations for each regardless of percentage.

"PDP sells for what PDP sells for whether it's in an upside package or a PDP-type package. Similarly, relative to price, upside sells for the same thing no matter which kind of package it's in," he said. "I see consistent prices for PDP and PDNP (proved developed nonproducing) no matter what the package is, and I still see a limit to the amount of PUDs you can put in a given amount of PDP before you're selling acreage instead of PUDs."

Richardson added that commercial banks are beginning to loan beyond PDP-only reserves, akin to practices last seen in 2007-2008. A loan today may fetch 20% to 25% based on PUDs, with 60% to 65% on the PDP value. The trick, he said, is in the bank's price deck. "Borrowers are hedging to inch up the price deck."

Williams said heavier PDP packages remain more attractive to MLPs. However, "there is enough evaluation delta that no one really has much of an advantage. We sell as many high-PDP packages to non-MLPs as we do to MLPs." The MLPs, though, as they have gained in size, have figured out that they can afford the risk to buy upside inventory and drill it out. "They don't need to buy all PDP anymore."

Spin moves

All panelists agreed that the trend of integrated oil companies spinning off E&P arms will continue, based on the value arbitrage created as independent oil and gas companies trade at higher net asset values. But the newly created E&P might join the independent market with a shock.

"These companies have to get ready to hit a treadmill that is running faster than they are used to running," Marko said. "ConocoPhillips is going to wake up after the spin and need to grow at 10% on the E&P side rather than 1% to 2%. Their new peer group is Encana, Devon and Chesapeake."

"They are going to be looking for large, sizzly acquisitions prior to the spin to provide production growth," Richardson anticipates.

Said Williams, "To grow, they're going to have to buy, because they are not going to be able to get up to speed organically."

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