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Advisors, CEOs, Private Equity

Oil & Gas Companies Focus on Core, Creating Opportunities for Buyers

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As oil & gas companies witness their cash flow shrink in this lower commodity price environment, many are evolving their strategies from reinvesting cash for portfolio growth into storm survival. One move E&Ps are making is to rationalize their asset portfolio in order to focus on their “core.” Principally, this means shedding properties not part of their core strategy for various reasons (geography, product type, non-operating vs. operating, etc.) and instead investing future drilling and exploration dollars elsewhere.

Small to mid-size E&Ps will probably need to monetize assets and may, depending on the strength of their balance sheet, even be forced to sell core assets. Without a stronger price environment rebound, mid-size and large producers are more likely to be in good shape until their hedges start to expire. A number of them are hedged through early 2016; beyond that, and without a strong rebound, they too could find themselves looking for liquidity. Because of this, the A&D market looks to be an active one later this year.

Those not familiar with the oil & gas exploration and production industry may wonder how companies determine their core. Savvy producers run through a check list of factors and weigh various options; these weights are usually based on net yield by operational area. They can maximize their enterprise value by focusing capex investments on producing asset fields that bear the best production-to-expense ratio. Once the company has defined its core, it can identify and determine which assets outside the core may be monetized. Other considerations include the valuation associated with the changes in their portfolio going forward and how the current development, production and reserves may be valued by the market in the future.

Efficient and tactical asset divestiture is an integral part of any forward-thinking E&P’s strategy. Assets are acquired, developed and produced. These wells will eventually run their useful life and be plugged and abandoned or, if product continues to flow and the wells remain economic, sold into the open market. How does a company take these assets targeted for divestiture to market? There are different acquisition & divestiture advisory groups available. The advisors offer different service lines depending on the type and size of the assets being marketed and what process would prove most effective. For assets greater than $100M, sophisticated negotiated transactions are preferred and physical data rooms that walk through the engineering, geology, and financial opportunity surrounding the asset(s) are required. For smaller asset packages, an extremely effective and competitive process may be desired through live and online auctions. The assets can be efficiently marketed to a targeted investing public via different vehicles targeting specific buyer groups. The key in any process is to create an efficient market where the asset is presented and packaged well so both buyer and seller have a meeting of the minds.

Sophisticated asset evaluation is paramount. Experts involved on both sides of the transaction contribute in their own way. Sellers are most familiar with their existing assets and should work with their own staff, or transactional support engineers, to present their best foot forward, fairly representing current cash flows but also highlighting potential upside value. Buyers will generally supply (or secure) buy-side engineering support which, not surprisingly, is typically more conservative regarding future value forecasts. Objective third party engineering evaluations usually provide a key “mean” by which both buyers and sellers can establish a negotiable middle-ground asset value. To drive the transaction to an efficient close, the value range – and gap – needs to be established early in the negotiations. Should the initial bid/ask price differential remain too great, negotiations are likely to stall or, worse yet for both parties, not even approach the table. Setting realistic expectations for both buyer and seller is imperative and any worthwhile advisory firm should do that up front.

The combination of all this activity creates a compelling market for new entrants and/or those that are well capitalized to take advantage of the near-term industry dislocations. New entrants may be able to get into producing assets immediately that they can then further develop and exploit – this has real value. They can do this provided the existing or near term cash flow justifies any further capex, and a number of proven fields – even with prices in the $50s – can do just that. The other option for new entrants is to engage in early-stage projects that consist of exploratory drilling on land/leases that have yet to be proven or developed, a process known as “wildcatting.” Current players in the industry with strong balance sheets can diversify their portfolio by acquiring existing producing assets as well as making bets on future prospects that increase their land position and possibly their reserve base.

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