Permian buyers capitalize on recovering market

The Permian basin proved to be the epicenter of US oil and gas merger and acquisition activity in the past 12 months and deals of all types are potentially on the table for the rest of the year and into 2022.

Timing of deal activity ebbed and flowed, but overall activity rebounded from the previous 12-month period, according to a June 18 Mercer Capital report by Justin J. F. Ramirez, senior financial analyst. Deal count over the recent 12-month period increased by five transactions relative to 2019-2020, according to the report. Median deal size increased to $405 million from $138 million, period-over-period. Median acreage among these transactions increased to 36,250 acres from 14,500 acres. Median production value over the past 12 months was 8,950 boe/d compared with 2,167 boe/d among transactions from June 2018 to June 2019. With the purchases, relative to the previous 12-month period, the median transaction value per production unit declined to $31,886 per boe/d from $53,584 per boe/d, the report continued.

Most transactions that broke the $1-billion mark over the past year—which included $75 billion in upstream deals with more than $20 billion in each quarter since third-quarter 2020 (with the exception of first-quarter 2021)—were either partially or entirely in the Permian basin, Andrew Dittmar, senior M&A analyst at global energy software as a service (SaaS) company Enverus, told OGJ late May.

“Buyers were ready to capitalize on a recovering market post-COVID and investors have supported consolidation in the industry,” he said.

Buyers and sellers

Public company consolidation held focus in 2020. Buyers like Chevron, ConocoPhillips, Pioneer Natural Resources, Devon Energy, and Diamondback Energy “targeted smaller public E&Ps that held high quality acreage but perhaps had a more challenging path to generating the free cash flow investors are looking for,” Dittmar said, noting synergies (operational, general, and administrative) were key drivers. 

Going forward in the large-scale M&A and consolidation space, one or two major deals in 2021 or 2022 in the Permian between similarly sized large companies are possible, said Laura Freeman, vice-president, business development and engineering, Vencer Energy LLC. “There have also been some companies growing by acquisition that are now at a scale that might be big enough to attract a buy-out by a large Permian player,” she told OGJ in early June.

Asset-level transactions were harder to come by, but that too could change.

“Last year was an exceptionally tough year for asset level transactions,” Freeman said. “That seems to have eased up with indications of significant deal market improvement starting mid-January. Given the backdrop of a very tight transaction market for a couple years now (coming off the 2016-2017 asset bubble), the stress of several private-equity backed and public companies, and the current oil price, we do expect a loosening of the market with more deals getting done at the asset level,” she said.

One sign of that loosening market is the recent deal struck by Occidental Petroleum Co. and privately held Colgate Energy Partners III LLC. In it, Colgate Energy agreed to acquire 25,000 net acres in the Southern Delaware basin (Reeves and Ward Counties, Tex.) from Occidental for $508 million. Current production is about 10,000 boe/d from about 360 active wells.

That deal also speaks to the private or private equity side of the business. The space is commanding more attention so far this year, Dittmar said.

Vitol Group’s upstream US oil and gas operations team, Vencer Energy LLC, pulled together one notable deal in that side of the business, buying Hunt Oil Co.’s Permian basin operations.

The acquisition, comprising 44,000 acres across five counties in Midland basin with current production of 40,000 boe/d, is the first for Houston-based Vencer—which was established in 2020—and positions the company “as a significant shale producer in the US Lower 48,” and “represents an initial step to building a larger, durable platform” in the space, said Ben Marshall, Head of Americas, Vitol, in a prepared statement upon the deal’s announcement Apr. 30.

While the Permian basin has been the headline maker for some time, Alexandre Andlauer, senior commodity analyst at Kpler, said the deal was a turning point for the basin, and perhaps signals the start of new entrants. Vitol has a good view of flow around the market, he told OGJ in late May.

“Vitol is massive. It’s more than a big oil company. They are doing billions and billions of revenues. For me, the move is bullish because they knew the oil, they knew the oil market, and they have money. Clever people with money. So, it’s a good sign.”

Asked if Vitol entering the Permian was a turning point, Freeman told OGJ the deal was certainly a turning point for Vitol.

The company has been considering an entry into US upstream oil and gas operations for a while and the large Midland basin acquisition was a bold move, she said. The Vencer team “found a great opportunity in a very tough deal market,” according to Freeman, noting that the company is “growth focused and not done looking for large acquisitions.”

As far as new entrants, she said she would expect “more consolidation across the Permian versus new entrants. Vitol and Vencer were in a unique position and had the right financial wherewithal to make a big move as a new entrant,” she said, noting she was “unaware of many other groups in a similar position after the last several years.”

Dittmar agreed that Vitol and Vencer were in a unique position. “Private companies have rarely competed with public buyers for core Permian acreage since the prices are generally high and public companies have an advantage in access to capital and capital costs. Vencer is a bit different than your average private buyer since it has the backing of global commodities trading powerhouse Vitol and its financial firepower. In that way it is a bit comparable to Surge Energy, which is affiliated with a Chinese conglomerate,” he said.

New companies buying into the Permian isn’t on his radar, but there are a few caveats, he said. “One is private equity picking up assets that are outside the development fairways of the major public companies on the edges of Midland or Delaware basins or in areas like the Central Basin Platform or NW Shelf.” Percussion Petroleum buying Oasis Petroleum assets in an example, he continued.

On May 20, an Oasis subsidiary agreed to sell its remaining upstream assets in the Texas region of the Permian basin to Percussion for up to $450 million. The assets consist of some 24,000 net acres and net proved reserves of 30.3 MMboe as of Dec. 31, 2020. First-quarter 2021 production was 7,186 boe/d on a two-stream basis of crude oil and natural gas.

Separately, Cabot Oil & Gas Corp. struck a deal with Cimarex Energy Co. While not a “new entrant,” Cabot’s 2020 net production was 100% natural gas from the Marcellus shale in northeastern Pennsylvania.

“Cabot is getting a new Permian runway through its merger with Cimarex, but that is a surprising deal and investors don’t seem entirely sold on it. In general, I think Wall Street would rather see Permian companies merge with one another where there are clear operational synergies. Combined with fierce competition for acquisition opportunities from the Permian’s established players, I don’t think we will see many new entrants,” Dittmar said.

As Dittmar noted, in 2021 so far, the industry has focused on the private or private equity side of the business.

In April, Pioneer Natural Resources Co. agreed to acquire largely undeveloped Midland basin leasehold interests and related assets of DoublePoint Energy for $6.4 billion. The deal represents a contiguous position of 97,000 core Midland basin net acres directly offsetting and overlapping Pioneer’s existing footprint, increasing Pioneer’s acreage position to over 1 million net acres with no exposure to federal lands. Production from the acquired assets is expected to reach 100,000 boe/d by late second quarter with annual cost savings expected around $175 million through operational efficiencies and reductions in G&A and interest expenses.

In May, Laredo Petroleum Inc. agreed to acquire the assets of Sabalo Energy LLC—an EnCap Investments LP portfolio company—and a non-operating partner for $715 million. Upon closing—expected in July—the company expects to hold over 30,000 productive, contiguous net acres in Howard County and a “near-term pathway [yearend 2021] to increasing our oil cut to more than 50% from the current 30%,” said Jason Pigott, president and chief executive officer, in a May 9 release.

The acquisition includes 21,000 contiguous net acres (86% operated, 100% held by production) directly offsetting Laredo’s existing Howard County leasehold with 120 operated oil-weighted locations (91% working interest) and 150 non-operated locations (12% WI). The assets are producing 14,500 boe/d (83% oil, three-stream) of low-decline production with an estimated next 12-month oil decline of 35%. Proved developed producing (PDP) reserves are estimated at 30 MMboe (73% oil, three-stream).

Such deals “may be a natural progression as the number of public companies to target is slimmed down by consolidation. The rise in public company equity valuations has also potentially made buying private companies a more attractive relative value proposition,” Dittmar said.

Relative to last year, he continued, the industry appears focused more on core inventory extension than synergies.

“Buying private companies doesn’t generally present as many opportunities for cost savings since they tend to run lean organizations. Public companies have also slimmed down costs substantially,” he said. In the Cabot-Cimarex deal, “there isn’t much in the way of operational synergies since they don’t share any basins and only modest G&A cost savings are laid out,” Dittmar said. A key driver for Cabot is addressing inventory concerns in the Marcellus position.

“With a focus on inventory, buyers are likely to continue to target the highest quality acreage available whether publicly or privately held. For smaller companies in the Permian, the consolidation of so much core leasehold under a handful of big players presents a real challenge to scale and grow. In these cases, an exit via a sale may be the best option,” he continued.

Acreage considerations, barriers

Multiple factors are evaluated when deals are envisioned. Top of mind is the acreage itself and how various tiers are considered.

“The increased oil price environment seems to be driving interest in optimizing drilling in various tiers of acreage,” Freeman told OGJ. “For the ‘sweet spots’ there is interest in optimizing spacing, mitigating drainage issues, and developing additional benches and infill locations. For Tier 2 acreage, the locations are much more viable at $65/bbl pricing. Tier 3 acreage and lower-quality benches of higher-tier acreage are attracting renewed interest at higher prices in light of the learnings and completions optimization work of the last few years. At $65/bbl oil there is definitely more interest in drilling and with any shale play there is always a focus on increasing production and maintaining base production rates as horizontal wells show very sharp declines after initial production.” All said, we’ll have to wait to see how that translates into M&A going forward, she noted.

While drilling has returned as top of mind, she said, “many investors and companies are approaching development with caution given the inflation of well forecasts and values over 2014-2017.” At this time, she added, bid values aren’t being heavily weighted towards undeveloped opportunities.

Perhaps unsurprisingly, the bid-ask spread remains a barrier for some deals. While there seems to be some convergence in the spread for upstream US onshore oil and gas assets in general, the Permian remains a bit of an exception, she continued.

“Many sellers are still trying to get the very high prices of the 2016-2017 run-up and asset bubble,” Freeman said. But buyers have moved up to get deals done in 2021, she said.

“One baseline for talking about deal value is in terms of present value or discount rate. The lower the discount rate, the higher the value. In the peak of 2016-2017 you would hear of people paying ‘PDP plus upside’. This refers to Proved Producing (PDP) or actively producing wells which were valued at low present value discount rates in the 0-10% range. Throughout 2020, many buyers were claiming it was a PDP PV20 market, meaning no value for upside and a heavily discounted present value of PDP in the 20% discount rate range. For many deals moving from PDP PV10 to PDP PV20 can mean a 30-50% reduction in bid value or offer price. However, nothing was moving at those offers. There have now been high-water marks post-2017 in the Permian, Eagle Ford, and arguably the Bakken. It will be interesting to see where the bid-ask spread settles throughout the rest of the year,” she concluded.

Along with the acreage considerations, commodity prices are a factor when it comes to deal making. Those prices, Dittmar told OGJ, seem poised to continue to support additional deals heading into second-half 2021. “At some point, the deal market may cool simply because so many of the reasonable deals have been completed and investors will push back if companies stretch too far,” he warned, but the opportunity for “winning deals” remains.