DALLAS—A&D math is changing because the structure of the upstream industry has changed, which affects A&D activity and capital inflows, said Doug Reynolds, speaking at Oil and Gas Investor’s 16th annual A&D Strategies and Opportunities conference.

“A key benchmark is net economic locations, which is a better indication of undeveloped value. So we’re starting to think about metrics differently,” said Reynolds, managing director and head of U.S. investment banking for Scotiabank.

“A couple of years ago we talked about acres. Then we were talking about effective acres where you stacked things up, but now we’re talking about economic effective acres,” said. “We think the economics of individual locations are really starting to matter. A location that doesn’t earn 20% at strip prices is being dropped out of the M&A analysis.”

Metrics on A&D deals are imprecise and change depending on who writes the press release, he said. Some buyers are big on acres, others on effective acres, others on locations. “Now we are thinking in terms of undeveloped economic locations … based on the perceived riskiness of a play,” he said.

The U.S. shale business is changing as activity in every basin shifts from discovery to full multipad development. In the past, operators were delineating single zones with single wells and trying to find new, deeper layers to drill. Today, they are well past that phase because of the cube concept—pads where wells are drilled in a large areal extent such as 2-mile laterals, into multiple, stacked producing formations.

This change requires much more capital, however, which in the end will be favorable to larger E&P companies, he said, and perhaps necessitating a new round of corporate M&A to build up the size of larger independents. “To drill 10 pads in a play at 10 or 20 wells apiece will require a lot of pipe, a lot of people, a lot of capital and a lot of everything else—that’s tough to do if you’re a small company.”

What’s more, a bigger corporate structure, one that has larger scale, more properties, more capital, is being rewarded by the stock market, Reynolds said. E&P companies with market caps of $8 to $60 billion are those that are driving production volume growth in the most active plays, not the majors and not the smaller players. They are getting rewarded in the market.

It will be important to see more equity issuance come back to the market to help A&D deals take place this year, he said. Private companies have made up about half of the sellers’ universe in 2016 and 2017, by selling assets to larger public E&Ps.

In the past large private E&Ps and international oil companies were active buyers, but now these large- caps have been better sellers than buyers, he said. The international buyers have been almost completely out of the market in the past two years, but he said he sees Asian buyers starting to make inquiries again for the first time since the downturn.

Smaller E&P companies that are not well valued face challenges: they have to differentiate and grow quickly, or find a new format, he said. Large E&Ps with stronger multiples are the buyers but they will be “super picky,” he said. He also sees more private equity capital coming into the sector and they will be buyers.

Enterprise value to EBITDA is positively correlated to company size, and owning positions in “good rock” is always number one. “Investors are rewarding those with scale efficiencies who can deliver clean volume growth and clean balance sheets.” Meanwhile, the stocks of “the big guys” since 2007 have been flat in market value, whereas the value of a group of super-independents has risen by a collective 88%, he said.

In the Permian alone, the super-independents are delivering 80% of the production growth; it’s not the majors, he added. “The market is saying, get me up to the scale of Parsley or Diamondback, and I’ll reward you…so we think that will drive some deals.”

Reynolds said the industry tends to see more corporate deals during times of low commodity prices, such as occurred after the economic collapse in 2008-2009. “Thanks to the growth of the super independents, we do see more corporate deals coming ahead, which would be different from the last two years” he said, although there have been only three so far in 2017, and one involved a SPAC (special purpose acquisition company) buying a private E&P. “We think there’s going to be more of that.”

Market sentiment can be a strange and inaccurate thing. Reynolds noted that more investors seem to be talking about, and honestly believe, that electric cars charged by plugging into a wall socket will take over fairly soon. “They have no real concept of what happens behind the socket. It’s a fantasy… this ‘Jetsons’ view of the world which I happen to think is incorrect,” he said. “It’s actually a serious matter because it affects how capital flows into the energy sector.

“Oil and gas will remain super-significant in the energy world [despite growth in renewables]. We are blessed in the oil and gas business by having a product that is in increasing demand every year. So it turns out oil and gas are useful products, and not just for transportation.

“This summer [this sentiment] started to beat up on the oil stocks … and we actually saw a large European bank [BNP Paribas] say it would stop lending to shale companies; I was shocked by that.”

Reynolds said under any scenario, oil and gas would remain “a super-significant” part of the energy mix.

He said production decline curves in plays around the world are greater than most people are acknowledging. He cited Pemex’s struggle with oil production declines in Mexico that have steepened over time. During this recent downturn most national oil companies have been cutting back on drilling, so volume declines are starting to set in, he said.