The Fuse

For Stable Independent Producers, Quality of Shale Assets for Acquisition Is Improving

by Leslie Hayward and Matt Piotrowski | April 11, 2016

It’s no secret that the U.S. oil and gas industry is going through very challenging times right now with commodity prices remaining at low levels for more than a year and a half. Some companies have taken necessary and creative steps to survive the downturn, and are well positioned to thrive and grow once prices eventually recover.

According to presentations at the Independent Producer Association of America’s (IPAA) OGIS meeting on Monday in New York City, a number of companies have proactively managed through the current environment by selling assets, reducing capital expenditures, focusing on core acreage, cutting management pay, laying off staff, cutting operating costs, renegotiating contracts, hedging production sales, and keeping open access to capital markets.

Strategies vary and some have weathered the low-price storm better than others, but presenters were more upbeat than expected, given how many bankruptcies and alarming debt levels are commonplace in the industry. At the same time, however, the number of companies presenting at the event is significantly lower than in previous years. Last year, some 75 independent producers gave presentations, but this year, only about thirty did. And many of the players are relatively small. Some have production levels of only 2,000 to 12,000 barrels per day.

However, most of the companies presenting at the conference are actively looking to scoop up distressed assets and pursuing merger and growth opportunities.

“It’s nice to be here today with $40,” said Lynn Peterson, the CEO of Synergy Resources. “$40 used to be low, but now it’s considered high.”

They may not be representative of the entire industry, which saw more than 40 bankruptcies last year and possibly a higher number in 2016. However, the issues these companies are going through do reflect industry’s struggles. They are taking measures to adapt just like bigger firms, with a focus on maximizing cash flow and reducing costs. The smaller companies presenting on Monday are generally better positioned than many of their peers, and are likely to succeed if oil prices keep rising.

“It’s nice to be here today with $40,” said Lynn Peterson, the CEO of Synergy Resources. “$40 used to be low, but now it’s considered high.”

NYMEX West Texas Intermediate (WTI) has rebounded above $40 after hitting a low of $26 in February. The rebound has given new life into shale companies, but they are still under stress because of their high-cost production, though break-even prices are falling.

The official for EV Energy Partners, an upstream MLP based in Houston, noted that his company has sold acreage in the Eagle Ford and the Utica, but also acquired some assets in the Appalachia Basin. Moreover, EV Energy has achieved a 75 percent reduction in E&P capital expenditures, which has lowered operating and capital costs. Another step that may not be too popular, but is necessary – reducing management pay by 10 percent. The company currently has $200 million of liquidity for capital needs, which is its “lifeblood.”

“We have sufficient liquidity to make it through for a while,” EV Energy Partners said.

Loose access to capital markets, whether through banks or private equity, has kept firms in the shale patch afloat.

EV said it will not be interested in acquisitions until prices recover, but others are open to mergers and acquisitions now. Vaalco, a Houston-based company with assets in Africa, is in conversations with others on joint ventures, asset sales, and merger opportunities. Like EV Energy, it has reduced pay for management, getting rid of cash bonuses. Steve Guidry, the Vaalco’s CEO, said the company also reduced its headcount by 40 percent in Houston. Moreover, its success in negotiating with contractors has helped. In all, the company was able to reduce operating costs by 32 percent in a year. Right now, it’s pleased with its $41 million in cash and its process of reducing costs and maximizing production. Any increase in Brent quickly adds cash to the balance sheet. Abraxas, which has a large focus on the Bakken, said there are a lot of distressed assets in the market now and it is looking to make purchases, but it’s waiting for the “right deal in the right area” which would create synergies with its existing resources. A number of other companys shared the same sentiment.

Debt management

Evolution Petrolem emphasized in its presentation that it has zero debt, and has had a positive net income in 18 out of the last 19 quarters.

The issue of debt among shale producers is an ongoing challenge for the industry: In January, Moody’s said it put 120 oil and gas companies on review for credit ratings downgrades. The debt of 10 companies was downgraded in February of this year by the S&P. Many of the companies presenting at this year’s conference are outliers. Evolution Petrolem emphasized in its presentation that it has zero debt, and has had a positive net income in 18 out of the last 19 quarters. The company reports a $7 per barrel development cost for their 2p reserves.

President and CEO Anthony Schnur of Lucas Energy, which is has acquired Segundo Resources and will be restructuring as Camber Energy, said, “We restructured our debt into a subsidiary that is now ring fenced.”

Jones Energy reports that it paused drilling in late 2015, taking 11 active rigs down to zero. With the money they saved, they bought back $171 million worth of their own bonds for $74 million, reducing nearly $100 million of debt.

Abraxas, which currently has $129.6 million of net debt, is in good position if prices continue to rally. It says it can start idled rigs in just two weeks since it already has crew on call. It has seven wells yet to be completed, but it needs higher prices for them to come online. One presenter from the company told investors, “It’s more about the trend than the absolute price,” noting that they will grow output once the upward price movement is confirmed.

Cost cutting

Jones Energy told investors that the cost to drill a well is now down to $2.2 million, far below the $3.8 million it took before the price collapse pushed the company to slash costs. The company has cut capital expenditures by 60 percent while increasing production by 10 percent. Meanwhile, its operating costs in certain plays are down 40 percent, lease operating expenses are down 30 percent, and general and administrative expenses are down 25 percent. The company’s CEO was highly optimistic about how the firm is positioned, saying, “Quick to get costs down means quick to return to the field.”

Memorial Resource Development Corporation, which focuses on natural gas, reports that last year they cut capital expenditures by 30 percent while increasing production 72 percent.

Lots of cost cutting has come in the form of reducing executive compensation and widespread layoffs. Vaalco energy reduced its staff by 40 percent to save $2 million per year.

Better assets becoming available

“The asset class that is becoming available to review for acquisition is improving. From our perspective, this is a terrific time to be in the oil business.”

One of the strongest themes among presenters at IPAA’s OGIS conference was the fact that for companies that are not struggling, excellent opportunities are emerging to scoop up assets and resources from other companies that have fared less well during the price downturn, and the fact that “good” assets are now becoming available.

According to Schnur of Lucas Energy, “The asset class that is becoming available to review for acquisition is improving. From our perspective, this is a terrific time to be in the oil business.”

Jonny Jones, CEO of Jones Energy, expressed similar sentiments. “There are a lot of opportunities in the mid-continent: Lots of people today are talking about the improvements in the assets that have become available within the last 6 months.”

Hedging

Proper risk management in a volatile market can make or break a company’s balance sheet, and that’s why hedging is so important. Companies vary widely in their hedging strategies. Evolution Petroleum, which produces 1,800 barrels per day but has carried no debt since 2006, says they are currently hedged at $40. “I hope we lose money on those hedges,” said the CEO, reiterating the industry’s hopes for a sustained upward trend in prices.

jones energy hedging

Jones Energy, the same company which reduced $100 million in debt last year, also has an unusual hedging portfolio. The company is 100 percent hedged at $100 per barrel through the end of 2016, and 70 percent hedged at $80 per barrel through 2017.

EV has been aggressive in its hedging strategies. For instance, it has sold forward 90 percent of its crude production from May to September (see below), and will hedge more if prices become attractive enough.

EVhedge

Abraxas, which has roughly 5,800 bd of production and is very active in the Bakken, has hedged about a third of its production for Q2 and Q3 at $39, and $43.25 for the fourth quarter (see below). For next year, its hedges average $55 and just above $46 for the year after.

Abraxas

 

With many producers across the industry struggling to maintain operations, it’s clear that a number of shale companies are not yet out of the woods. However, for those who have streamlined operations while keeping their debt under control, there’s tremendous upside as better assets become available for acquisition. Furthermore, the price downturn has enabled the industry to develop better practices that will strengthen it in the long-term.