Natural gas and oil transactions to date are down about 20% this year from the same period of 2011 "in both the number and the transaction volume," but a lot of money remains on the table for dealmaking as the market strengthens, according to the CEO of Tudor, Pickering, Holt & Co. (TPH).
Bobby Tudor, who also chairs the energy investment and merchant firm, offered his insights as a keynote speaker at the World Shale Oil & Gas Summit in Houston last week. 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."
Significant interest in energy development is ongoing around the world, but the onshore United States "remains the No. 1 place for investment...A lot of capital has gone into the business in the last three or four years, but this business requires a lot of capital. The likelihood for deal activity...continues to be high."
Mergers and acquisition (M&A) activity remains "robust," with 10-15 big deals a quarter over the past eight to 10 quarters, excluding joint ventures (JV). 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..."
Today dealmaking remains slow but by 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."
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 equity markets continue to discount at $4.50 to 45.00 in stock prices, away from spot prices. 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..."
For the past two years, coinciding with the rise in oil prices, the "overwhelming majority of oil and gas transactions have been in resource plays," through JVs and going it alone, said Tudor. But "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..."
Like commodity prices, transactions in the past two years have shifted, with 79% of the deals since January targeting oil and liquids, 21% targeting natural gas. That's a huge change from two years ago when more than half of the deals (53%) targeted natural gas and 47% focused on oil and liquids, Tudor noted. Last year 62% of the deals were for oil and liquids.
In North America, "clearly what is different today from the last five years is that technology continues to evolve in a fairly dramatic way," Tudor said. "Companies are spending very substantial dollars on R&D [research and development] to drive down costs and drive up recoveries. It's a very important item in the overall scheme of things and technology is going to be the driver and make the plays economic for years to come."
When gas prices rebound and producers scramble back to the gas patch,the industry should be able to quickly respond, he said. A lot of equipment has been moved to liquids and oil plays, but "the U.S. gas industry is is actually pretty nimble and it moves quickly...It certainly has a history of being able to turn when the economics have demanded it...I expect the industry to be able to do that and I do not see [a lack of equipment] as a bottleneck."
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..."
Meanwhile, natural gas liquids (NGL) prices have fallen 34% since they peaked in 2011, Tudor noted. Ethane prices have fallen 68% over the same period.
"With NGL prices falling, positive production economics are more difficult to obtain," he said. Investors are "looking for liquids...but there's a big difference" between oil and NGL investment in the United States.
Today the money is on oil, not NGLs, "the most volatile market," and quite different from "natural gas because we have a lot more supply but not the same amount of increases on the demand side." NGL supplies are expected to keep increasing -- while demand is expected to keep stagnating -- well into 2013.
North American supply growth with declining U.S. demand "means the discount to global crude prices will persist.' assuming a discount to Brent crude oil, "we get to $87/bbl as long term West Texas Intermediate."
For U.S. oil prices, "we've actually had pretty good stability in oil prices in the last couple of years, which has lent itself to an active deal market. And we see a sustainable price over time." There will be swings in near-term spot prices, but the "outlook is largely the same."
Against the equity and trading backdrop, "most traders are pretty grumpy these days despite the higher oil prices," Tudor said. "It's a hard place to make money. Some basins have performed miserably. Any basins 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.
Tudor presented some companies' recent earnings information to illustrate his point.
The enterprise value (EV) per 2012 gross earnings multiples puts the Marcellus Shale-focused companies at 12.9 times earnings, versus "focused gas growth" company stocks at 8.5 times earnings, according to FactSet as of Sept. 13. "High oil growth" companies and the Permian Basin-focused companies both performed at 8.1 times earnings multiples; "transition" plays were 6.7 times, diversified gas growth stocks were 6.0 times ; small cap gas companies were 5.5 times; oily companies were 6.1 times; and Gulf of Mexico (GOM)/Gulf Coast companies were 4.4 times multiples.
However, measuring EV per current production performance, or per boe/day, the Marcellus Shale-focused companies measured $15,636/boe per day, versus high oil growth company stocks that measured at $27,862/boe per day, while Permian Basin-focused producer earnings were at $21,957/boe/day. The oily stocks were at $15,140/boe per day. Those making less money were transition plays, $13,662/boe/d; focused gas growth, $10,212/boe/d; GOM/Gulf Coast, $9,497/boe/d; small cap gas, $9,261/boe/d; and diversified gas growth companies, $8,662/boe/d.
Although natural gas prices are discouraging to traders, the "interest in LNG exports from places like the United States is very, very high," said Tudor. "The Middle Eastern tensions on oil prices are not going away soon. The Asians have found it impossible to vanquish their thirst for gas, which is driving activity around the world...All of that background today, virtually any oil executive today worldwide would say that unconventional oil and gas in the United States has become, and we think will continue to be, a very attractive place for investment over the next decade. We see lots of that, not just in the United States, but internationally."
The U.S. drilling rig count, and ultimately production, have "done a real flip flop in the past three years or so on oil and gas," noted Tudor. Analysts have been keeping an eye on the vertical rig count drop and the rise in horizontal rigs, which have jumped "dramatically. We would expect that regardless of where the commodity price goes, and this will continue to be in place for the indefinite future."
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