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It's a Buyer's Market -- But Few Buyers Available

North American producers of all sizes have reduced their spending and drilling plans this year, and some highly leveraged companies are attempting to hold their operations together in the face of low commodity prices and a tight credit market. The acquisition and divestiture (A&D) market is slow, but some smaller players with solid balance sheets and liquidity are letting it be known that they might be interested in a few choice assets.

For those with liquidity, like U.S. Energy Corp., a Riverton, WY-based natural resources exploration and development company, it's a good time to look for assets. The company has retained Houston-based SMH Capital Inc. to act as a financial adviser in its quest to acquire some natural gas and oil properties.

"With overall continued market uncertainty and commodity prices remaining depressed we believe now is the ideal time to enhance our acquisition strategy by working closely with SMH to seek out high quality oil and gas assets," said U.S. Energy COO Mark Larsen. The company wants to up its production rate to around 7,000 Mcfe/d by the end of this year, but "we're not limiting our corporate objectives in this endeavor."

Larsen previously was president of Rocky Mountain Gas Inc., a coalbed methane company that was sold to Enterra Energy Trust in 2005. He also is a former director for Pinnacle Gas Resources, which was founded by Credit Suisse First Boston. By leveraging SMH's contacts and expertise, he said, "we intend to use our solid balance sheet to selectively and efficiently access what we believe is a growing pool of attractively valued exploration and production stage oil and gas assets."

BMO Capital Markets analyst Gordon Tait said he expects to see more transactions in the coming months.

"I would think that for companies that follow a strategy of buying in the trough, this is obviously a much better time to buy than a year ago or even two or three years ago," Tait said. "Oil prices are back down to where they were in 2004 so you're presumably picking up assets at the bottom of the market."

Calgary-based Vermilion Energy Trust is one of a number of smaller producers that plans to take advantage of the economic downturn, CEO Lorenzo Donadeo said last week.

"Vermilion's strong financial position should enable the trust to capitalize on weak commodity markets as acquisition targets become more numerous and acquisition metrics become more appealing," Donadeo said. Potential acquisitions would be North American or European gas assets.

"The biggest challenge right now, to be quite honest with you, is there seems to be a lot of opportunities," said Donadeo. "It's about choosing the ones that seem to make the most sense." Vermilion, he said, has a "significant amount" of credit available and could buy up to C$500 million without raising more money through an equity financing.

Pengrowth Energy Trust CEO James Kinnear also expects to see more takeover talk in the oilpatch. His company, also based in Calgary, is mostly interested in opportunities among the Canadian energy trusts.

"We believe that over time there will be more consolidation within the trust sector, partially because of the economic environment and partially due to economies of scale and cost savings," Kinnear said Tuesday during a quarterly earnings conference call. A Canadian tax on income trusts is expected to take effect in 2011, which should spur activity, he said. Pengrowth has cut distributions and its capital spending plans for 2009 to ensure that it has enough financial flexibility for any opportunities that come its way, said Kinnear.

Some in the industry thought the market would be flooded with property sales this year, but it hasn't happened yet. Instead the deals have been similar to the C$750 million asset legacy sale by Talisman Energy Corp. to junior explorers Crescent Point Resources LP and TOG Partnership, an affiliate of Tristar Oil & Gas Ltd (see related story).

Crescent Point CEO Scott Saxberg said his company expects to generate substantial rates of return on the Talisman properties even at today's low commodity prices.

"We are confident in the oil markets and the ability to add value in this time period," said Saxberg. "The projects that we are developing at this price level are good returns for us and are strong, and so we are not afraid to continue to grow." The partners plant to issue shares and use their credit lines to pay for the assets.

"Is it a bit daring?" asked Tristar CEO Brett Herman. "It is, in the sense of raising money in a very volatile environment right now. We are not taking a short term view. We believe that commodity prices are going to come back, and so when you take a long term view of the assets, they are going to be here for many years."

Waiting out commodity prices or an upturn in the market may not be available to every company. Canadian Superior Energy Inc. on Friday said its application seeking court protection from creditors was successful. All claims against the producer and its assets have been stayed, the company said. The court order, effective until March 25, will allow Canadian Superior to prepare a plan to pay creditors, which includes the proposed sale of a quarter stake in a promising gas discovery in Trinidad and Tobago (see NGI, Aug. 28, 2008).

Junior explorer Gasco Energy Inc., based in Denver, has released its single drilling rig from operations and reduced its 2009 capital spending budget. Now it's trying to hold on in a tough market.

"We recently announced a revised initial 2009 capital budget of $10 million, which is in line with what we anticipate for internally generated cash flow from operations during 2009," Gasco CEO Mark Erickson said Thursday. "While a maintenance capex [capital expenditure] is not what investors want to look for in a growth company, it is a necessary and prudent measure that will help us to persevere through a particularly difficult year that 2009 is setting up to be.

"We are fortunate to have options to weather the storm during a down commodity price environment," Erickson said. "We are seeing service costs soften as our vendors are becoming more competitive to keep their equipment and people busy in the field. Our major capital items, including drilling, pressure pumping and steel are 30% to 40% lower than their peaks in 2008. We believe this trend will continue given the aggressive reduction and development activity by industry. Lower service costs obviously are an important input in calculating per-well economics. The lower cost should allow us to stretch our $10 million budget in the program for 2009 while improving rates of return."

Gasco has brought more contract services in house, Erickson said. And the company has set an internal goal for reducing general and administrative expense by 15-20% in 2009 exclusive of noncash compensation expenses.

"The majority of our staff have endured multiple cycles in this industry and understands what it takes to survive a downturn," said the CEO. "It is by no means enjoyable, but oil and gas professionals are a resilient group. Gasco remains focused on being able to capitalize on a revitalized natural gas market when it returns, as it always does."

Though there are some companies desperate to sell noncore assets, the A&D marketplace currently is slow and it may not get much better through the rest of the year. Investment banker Rob Bilger, a managing director with Tristone Capital, said recently that Tristone had been anticipating an active fourth quarter because of its record setting pace in the first three quarters of 2008. That was not to be.

Through last September Tristone closed on more than $7 billion of transactions in the United States. Toward the end of the year the cost of capital increased, money that had been available disappeared and to top it off, commodity prices plummeted. Many transactions were pulled from the market.

What is encouraging for the market are the successful debt offerings -- even at a high cost of capital. For example, El Paso Corp. raised $500 million at 15% in late December; Devon Energy Corp. raised $1.2 billion at 6% in January.

In this environment, it's too soon to tell how this year will be for the acquisition and divestiture market.

"It depends on how prices react and particularly how credit markets respond," said Bilger. "If prices rebound and stabilize and the credit markets continue to improve, then the second half of 2009 could be quite active..."

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