Mounting Wave of A&D Moving Away from West Texas

Apart from mega-deals and west Texas, the market for the buying and selling of oil and gas properties has seemed to be in the doldrums for over a year. Now that appears to be changing, and it could also change the trajectory of deals in west Texas.

Buyers may like dropping prices, but sellers don't. While potential sellers in inactive basins mostly held during the cycle, record levels of available capital from private equity searched for opportunities. Like a magnifying glass, the environment focused attention and investment into the Permian, heating up prices and activity to scorching levels. Large and high value deals were done in 2016, but deal flow of smaller assets and other basins was choked.

Commodity prices and price expectations mostly stabilized starting last summer. Still, the level of comfort with price stability is just catching up, and the constellation of price expectations by industry segment is finally returning to its normal arrangement. The charts below show historical prices and various price expectations for both oil and gas. (The graphs and the data can be downloaded at no cost here.)

 

The flow of deals did pick up a little in the last quarter, but mostly the assets available for the last year or more seemed to be fewer and sub-standard. Our firm evaluated a lot of offerings over that time which turned out to be scarcely economic or otherwise unattractive (read "crappy").

It looks like, however, the gates on the pent up supply are beginning to open. Both brokers and investment bankers have been arriving in the market with more mandates, and rumor has it that their pipelines are so full that some are turning away work. Already I've been more quality deals and of more manageable size in 2017 than I saw in all of 2016.

If my observations hold up, then now is the time to gear up business development teams and to refine evaluation procedures. Our website includes some free resources to speed your process, and consultants (like our firm, of course) are glad to help.

On the other side of the strategy the shift may also, ironically, signal the beginning of the end of the bubble in west Texas. First, to be clear, no modern resource play has yet avoided the problem of being overbought. Every play I've seen so far has contracted within a few years as the geologic limits on economic returns are tested.

Second, the macroeconomics of demand and thus cost inflation are beginning to show. Since the industry has turned to massive, regional developments, we have consistently under-appreciated the impact of large scale demand on costs. Whether rig rates in the Barnett in the mid-2000s, price differentials for Marcellus gas, or just day-to-day operating costs, we have consistently assumed flat to dropping costs while they mostly moved upward. Many public investor presentations assert that cost savings are sustainable. The track record, though, of investor presentation predictions is, in my experience, poor.

Anecdotal reports indicate that service costs are already up 20 to 30% from their bottom. The service companies had offered bone-cutting prices just to try to stay in business, but as one provider said, "We are tired of working for practice." With so much activity ramping up in one focused area, the nasty macroeconomic realities of supply and demand are likely again to rear their head.

Lastly, and returning to our starting point, the flow of opportunities in other places creates opportunities to refocus the attention and capital of buyers. The heated passion of uninvested money may shift away as it courts other basins. In the near term, the rush of interest may drive competition for non-WTX assets to unexpectedly high levels, but it may also drive west Texas prices to disappointingly low ones.