Buyers Beware: Minding the Details in Oil & Gas Acquisitions

Caveat Emptor means literally "let the buyer beware", and this is good advice when buying oil and gas fields.

Whether in the standard contract for an auction site or in the fine print on the disclaimers page from an investment bank, language like the following is pretty standard:

"SELLER does not warrant or represent as to the accuracy or completeness of the data presented."

SELLER offers the PROPERTIES "without warranty whatsoever, express, statutory, or implied as to description, title, condition, quality, fitness, merchantability, or otherwise."

Whoa.  For me, this reads like the kind of disclaimer I'd expect for a 1993 Honda Accord on Craig's List.  (Ask me sometime; I'll tell you my sad tale.)  The seller has made it, or tried to make it, contractually permissible to conceal relevant information and to provide unreliable data, despite obligations in state law.  Hence, the buyer of properties shouldn't take for granted that something not discussed is in good shape.  Though they certainly won't say it and though they are unlikely to point it out,  many properties go up for sale because they have serious warts.

A couple of years ago I visited a data room for a large non-op position in an emerging shale play.  There were close to two dozen wells in total, but only a handful with more than a couple of month's production history. The seller gave us good, complete daily production data so that we could see just how good the wells were, and they forecast production with nice, slow, steady declines as had been seen to date.  The broker's analysis showed >50% rates-of-return and that the whole development was approximately self-funding, requiring little to no out-of-pocket capital. (Brokers are, after all, salesmen and not providers of independent opinions.)

Asked why the client would sell such an attractive asset, the broker asserted that they wished to deploy their capital elsewhere, and, to me, that was French for "we don't believe the wells will be that good."  Where else could the seller get 50% ROR?  And if no capital was required, then why not let the project run?   A deep dive into the data showed an explanation of the low declines: opening chokes.

Flowing pressure had been declining naturally in the young wells until about the time the sales process started. Then chokes were systematically opened throughout the field, boosting production and giving the appearance of flatter declines.  The chart below shows a single well from the package which was being marketed in the fourth quarter of 2013, and this example was representative. 

It is worth noting that the operator of the package, a former high flyer, entered bankruptcy this year.  It is a good thing that we did ask the deep questions.

Do you have any stories others could learn from?  Please feel free to post them below.  You can also check out this Prezi which I delivered to the Oklahoma City Section of SPE last week.  I'd be happy to give the same talk to your society lunch as well.