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U.S. Onshore Still Tops for Investment, Says Tudor

The onshore United States "remains the No. 1 place for investment" and the likelihood for future dealmaking "remains high," according to Tudor, Pickering, Holt & Co. (TPH) CEO Bobby Tudor.

The energy investment and merchant firm chief offered his insights earlier this month as a keynote speaker at the World Shale Oil & Gas Summit in Houston. Tudor was a partner at Goldman Sachs before he founded the Houston firm in 2007, and since 2010 he has helmed 65 transactions with total deal value of more than $77 billion. The firm's 150 geologists, engineers and financial bankers are housed in four offices in the United States and in London.

However, "investment bankers and equity investors are not the drivers of the energy industry," Tudor told the audience. "The drivers are the geologists, the geophysicists, the engineers...who make it all happen in the field. That said, it requires a lot of money, a lot of access to capital to develop oil and gas. And the scope of it is driving the deal business."

Excluding joint ventures (JV), merger and acquisition activity has been "robust," with 10-15 big deals a quarter over the past eight to 10 quarters, Tudor told the audience. However, there was a "fairly dramatic slowdown earlier this summer when oil moved below the $90s to the high $70s and it spooked buyers," which resulted in a "gap on sellers' and buyers' expectations..."

Dealmaking remains slow today but in the final three months of this year activity again should pick up, said the TPH chief. "The metrics have been pretty steady in the past year on the oil side, whether you are measuring it on a reserves basis or on a production basis."

But "you can't talk about the deal business without talking about commodity prices..." For natural gas, TPH is assuming a long-term price of $5.00/Mcf and mid-term price of $4.25-4.50/Mcf. Gas prices are "predicated on the assumption that cheap gas prices versus crude sufficiently stimulates industrial and transportation demand, which combined with LNG [liquefied natural gas] exports, results in a higher natural gas price," said Tudor.

"Obviously, after having a significant drop to the low $2's, the forward curve is anticipating gas rebounding to the mid $4's in the intermediate term and closer to $5 in the longer term. It all depends on industrial demand, some LNG exports, some amount used for transportation fuel in the United States...We would expect higher natural gas prices over time. The question is the timing and magnitude of the demand response and LNG..."

Natural gas deal activity overall has "clearly slowed down fairly dramatically. There's not a lot of appetite outside a fairly narrow band of buyers on exposure today...The consensus is that gas prices will be substantially higher than they are today, and the metrics have remained reasonably steady...There are still a fair number of buyers for gas..." Master limited partnerships are "looking for low decline, long tail properties that can still produce long-term returns..."

The "overwhelming majority of oil and gas transactions have been in resource plays," and "there's not a lot of activity in the conventional basins. Beginning in 2008, the number of unconventional deals dramatically outpaced conventional deals. JVs, non-JVs, all of the capital is going into unconventional. JV partners, to Chinese national oil companies, to Japanese trading houses, etc. The kind of people we have conversations with never ceases to amaze us..."

Against the energy equity and trading backdrop, "most traders are pretty grumpy these days despite the higher oil prices...It's a hard place to make money. Some basins have performed miserably. Any basin with a higher oil component outperforms those with gas, and that continues to be the case...But recent market downdraft is affecting most" onshore basins.

The "oil stories continue to outperform and continue to trade at premium valuations," Tudor said. Using FactSet information as of Sept. 13 to illustrate his point, he showed how the pre-tax earnings for producers stack up against each other in the United States, depending on where they operate.

For instance, the 2012 estimated enterprise value (EV) for pre-tax earnings multiples for three of the biggest Marcellus Shale producers -- Cabot Oil & Gas Corp., Range Resources Corp. and EQT Corp. -- averaged 12.9x earnings. The "focused gas growth" producers that included Goodrich Petroleum Corp., Quicksilver Resources Inc., Range, Southwestern Energy Co. and Ultra Petroleum Corp., the 2012 EV averaged 8.5x earnings.

"High growth oil" onshore producers Continental Resources Inc., Concho Resources Inc., Denbury Resources Inc., Oasis Petroleum Inc., as well as "Permian" producers Approach Resources Inc., Clayton Williams Energy Inc., Laredo Petroleum Holdings Inc. and Pioneer Natural Resources Co., both had average EV earnings multiples measuring 8.1x. The "transition" producers, with EV earnings multiples measuring 6.7x, included EOG Resources Inc., Rosetta Resources Inc., SandRidge Energy Inc. and SM Energy Co.

The "diversified gas growth" producers with EV multiples of 6.0x earnings included Chesapeake Energy Corp., Devon Energy Corp., Encana Corp., Forest Oil Corp., Newfield Exploration Co., QEP Resources Inc., Exco Resources Inc. and Cimarex Energy Co. Bill Barrett Corp., Comstock Resources Inc., GMX Resources Inc., PDC Energy Inc. and Penn Virginia Corp., considered the "small cap gas producers," had estimated EV earnings multiples of 5.5x.

The "oily" producers, grouped as Berry Petroleum Co., Plains Exploration & Production Co., Resolute Energy Corp., Venoco Inc. and Whiting Petroleum Corp., had an EV earnings multiple measuring 6.1x. And Gulf of Mexico/Gulf Coast producers overall had an a 4.4x multiple for 2012.

However, if the EV per current production performance, or per boe/day is estimated for 2012, the "Marcellus-focused" operators are earning on average $15,636/boe per day, versus the "high growth oil" company stocks, which are earning about $27,862/boe per day. "Permian" producers are earning about $21,957/boe/day, the statistics indicated.

The "oily" stocks earnings have averaged close to $15,140/boe per day. "Transition" producers make an average $13,662/boe/d, while "focused gas growth" earns about $10,212/boe/d. In addition, "Gulf of Mexico/Gulf Coast" producers earn on average $9,497/boe/d, while "small cap gas" operators earn about $9,261/boe/d, and "diversified gas growth" companies average $8,662/boe/d.

Like commodity prices, mergers and acquisitions in the United States onshore over the past two years have shifted, with 79% of the deals since January targeting oil and liquids and the rest for natural gas assets. The new sales targets are a huge change from two years ago when more than half of the deals (53%) were for natural gas versus oil and liquids, Tudor said. Last year 62% of the deals were for oil and liquids.

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