When commodity prices fall off as they have the last eight months, companies begin to high-grade their portfolios or seek a way to lower costs. In the high-grading exercise, they are either wanting to dispose of assets that will not compete for capital in the environment they see for the next few years or want to acquire assets that help round out their acreage portfolio with the same mindset. Sometimes they are selling with one hand and buying with the other.
“Horse-trading,” or high-grading, is as old as the oilfield. There is lot of horse trading going on these days in the Permian basin with Chevron (NYSE: CVX), announcing the desire to sell some of its Permian properties. In what became a very busy day, TRP Energy, largely owned by a Private Equity firm, Greenbelt Capital Partners, announced that it was looking to monetize its Permian assets in the Midland basin, and seeking $1.5 bn to cash out. And, that’s just this week.
In the case of lowering costs, there is nothing like a merger, particularly if it’s a stock swap that leaves the surviving company relatively free of debt and able to compete in a declining market. We have seen a lot of that in the last couple of years. Some, like ExxonMobil’s (NYSE:XOM) rumored merger with Pioneer Natural Resources (NYSE:PXD) remained stuck the rumor stage with no official announcement forthcoming from the companies. This in spite of the compelling arguments for the merger I put forward in an OilPrice article at the height of the tempest. Not every rumor comes to fruition obviously, but that doesn’t mean the wheels of M&A aren’t churning just down the road.
Part of the rationale involves the recognition that the number of participants in a fragmented play needs to be reduced in a “Roll-up” strategy. This brings the benefits of scale to the acquirer, which then utilize these assets more efficiently. A recent wrinkle in the general interest in M&A activity is the entry of non-operating companies providing capital to consummate a deal, while taking a working interest.
Energy analyst and consulting firm RBN Energy summarized the rationale in a recent blog post.
“Today, oilfield service costs have risen, increasing production costs, and as DUC inventories are depleted, producers must invest more to rebuild their inventory. Therefore, scale matters, and location matters. If a company can negotiate better terms with a service provider or midstream company because they can utilize assets for longer due to more production, reserves, or inventory – whether it’s using a rig crew or shipping a molecule – this will incentivize more production as the marginal cost of production per unit will be lower. The drive to consolidate acreage in the premium shale plays will no doubt lead to significant future solicitations to the non-op companies to participate in transactions with small or mid-size operators.“
The latest example of this merger mania is Earthstone Energy’s, (NYSE:ESTE) $1.5 bn all-cash deal ($1.0 bn net after a $500 mm working interest buy-in to Northern Oil and Gas, (NYSE:NOG) for 33-1/3% of the deal), for privately held Novo Oil and Gas Holdings, Delaware basin acreage. If you are reading this article you probably know that the Delaware is the hottest play on the planet now due to its stacked reservoir horizons in the Wolfcamp A, B, C, and D, as well as the Upper and Lower Bone Spring that make multi-laterals and Super-fracs economic. The Permian basin is the only shale liquids play where monthly output is still rising. The Delaware sub-basin is a big part of the reason.
This most recent buy caps a torrid streak of M&A activity since 2020 by Earthstone, participating in 7 transactions totaling $2.5 bn. It’s taken a toll on the balance sheet, but during that time production has risen from ~15K BOEPD to ~100K BOEPD. With the 1/3 non-op NOG participation in Earthstone’s deal for Novo, the balance rises above its 1.0 D:E target in 2023, but the company forecasts bringing back into line in 2024.
The investment case for Earthstone Energy
The investments for Earthstone is underpinned by a solid P-10 reserves base that exceeds their Enterprise Value-EV by a factor of 2. This is unusually strong and speaks to the skill of management in putting past deals together that they are not burdened with excessive debt. It also is bolstered by the ~1,020 PUD drill sites spread across the key producing counties of the Permian basin, once the Novo deal closes. This will allow for steady increases in production with the company’s 5-rig drilling program.
The production that Novo brings will catapult Earthstone’s daily output by 33% at year end, when the transaction closes, while lowering the percent oil and liquids by (4) and (2) percent, respectively. The company…
Read More: Commodities And Consolidation: Earthstone’s Bold Asset Swap Strategy