I was lucky enough to recently have a piece of a big producing asset sale recently in what might be termed an "Unconventional Resource" oil and gas play. An "Unconventional Resource", to those non oilpeople that happily stumble across this blog, is the thing that wet oilman dreams are made of. Real lubrication. Forget jets and hookers. The best thing? We are finding them across the whole USA... mostly gas, but a fair amount of oil starting to flow as well. The even more interesting part? We are finding them in old oil and gas basins that we have drilled through hundreds of thousands of times and that we never recognized being there in the first place!
This has had a phenomenal effect on the price of leases. Old style Conventional oil and gas projects... $10-$200 an acre. Unconventional Plays? $400 to $15,000 an acre. What, just 5 or 10 years ago, might have bought a farmer a new pick up truck as a bonus on the 160 acre tract now could buy the old boy an island in Micronesia. In other words, these are a BIG DEAL, and they are adding HUGE reserves of good ol' US born and bred oil and natural gas to offset the "damn furrin'" stuff, and helping the trade deficit and the economy, particularly the rural economy, along the way.
In any case, let's compare this deal to a "Conventional deal" of 5 or 10 years ago.
In this recent divestiture, we got paid $25 per barrel of oil equivalent for Proven Producing Reserves. We got paid around $12 per barrel of oil equivalent for Proven Undeveloped Reserves... the stuff engineers say is recoverable between the current wellbores and obtainable at no geological or reservoir risk by drilling a new well, meaning you are only dealing with mechanical risk of drilling to get at the resource.
To drill, complete, and frac one of these wells will cost you $14 per barrel of oil equivalent net to to 100% working interest. This means that we sold yet to be drilled locations for a slightly highercomponent price as a proven producing well ($12 per barrel for the location + $14 for the drilling cost = $26 versus $25 for the already drilled producing wells). That´s like selling a commercial lot for the NPV of the business that will locate there minus 97% of the building cost. Woof.
These are the important facts. Other facts are that the engineers tell us this play will produce 750,000 barrels of oil per section. Given that this play is at least 600 sections (our puny piece was 12 sections, or a maximum 2% of the play), we are in the range of a half a billion barrel oil field. Oh yeah. This also suggests that this play, by itself, will contribute 30 to 50 billion new dollars to the US economy, and spread out pretty widely. It is also one of many of these emerging.
How does this compare to the "old days" before we knew about these "Unconventional Resources"?
Acquisitions could be had on a reserves basis of between 1/3 to 1/4 the price of a barrel of oil equivalent in Proven Producing Reserves. PUD's, if you could get ANYTHING for them, were likely to fetch you 1/30th to 1/4oth the price of a barrel of oil equivalent. The big differential here is the PUD value, and the decreasing "risk discount" put on a PUD barrel. In fact, in this case, you can see that there was NO risk discount on the PUD. In fact, the PUD barrels were not time discounted either. They were, in fact, given a Premium!
Why is that? A couple of reasons come to mind. The first is that one of the purchasers was Publicly Traded. They bought two years of steady reserve and production growth, and, with it, predictable revenues and earnings growth... mother's milk to an oil and gas company. Publicly traded oil companies sell for more than their reserves are worth, usually, so what you see is a Public Valuation arbitrage. "We lose money on every sale, but we make it up in volume".
The second reason would be the pile of private capital looking for somehere to invest. These guys have preferential rights on getting their money back with some sort of coupon... ie an interest rate that would make the old time usery folks blush, along with a significant equity kicker. They bet on "proven management teams" who are proven by having done it once before. Like betting on a coin toss being heads because the last flip was heads. You gotta have a method, I guess. Don't get me wrong. There are some incredible teams out there that are the Real Deal. They don't pay these rates. It's the other guys that Hope that they are a Real Deal.
Since they are going to get first money out and great rate of return locked in, their are plenty of folks that will take the money on a non-recourse basis. Like playing the slots in Vegas with someone elses money with the only proviso being you have to pay the first 1.30 in winnings per dollar you spend back to the person who gave you the money.
In other words, it is a perfect storm. A great confluence of events in which to to sell producing "Unconventional" assets. The time window is dictated by two factors: The Price of Oil or Gas... actually, more importantly, the Future Oil and Gas Price deck. Todays spot price is much less important. The futures decks dictate whether you can lock in a 1, 2 or 3 year price for your products, thus insuring the asset you are buying against commodity price risk. The second factor is the discount rate. With the Fed keeping interest rates low in order to avoid a housing mortgage meltdown, income producing assets can be sold for breathtakingly high prices... ie the equivalent of a Cap Rate in real estate. With low interest rates, a 6 or 8 percent return looks attractive when T-bills are at 3 or 4%. When T-Bills are at 6 or 8%, then the real estate or oil and gas properties have to produce minimally 10% or higher. To get higher returns, the asset you buy has to have a lower acquisition cost relative to its cash flow stream. In real estate, you can raise the rents to maintain value. In oil and gas, you.... do whatever the world market tells you to do. Basically, you are held hostage by swing producers, the latest, and perhaps late, thought to be Saudi Arabia.
As a domestic producer, you are also ready to get gutshot by politicians, who apparently blame the independent US oil and gas producer for the fact that we don't have windfarms that are efficient but nonetheless are subsidized to create a trillion dollars in sales for GE and for farmers that are too stupid to raise crops that have the magic properties our legislators mandate... like high BTU efficiency to power vehicles AND provide a food crop. Damnit farmers! We wanted Candy Cane crops, you losers! Why else did we subsidized to the tune of billions per year, primary to super giant corporations?
But, you say, Choke, we hate Big Oil, not you guys! BS I say. If that were the case, you would tax imported oil to pay for follies. Instead, we see US well head taxes and takings as the preferred method at "getting at big oil", never mind the fact that they have a disproportionately small amount of US well head production...
The Fed today is walking a tightrope. It WANTS to raise rates, so as to more attractively sell our debt in a sinking market to the Chinese, perhaps our Real Mandarins, ironically. Our Inscrutable Dollar savers/saviours might lose interest in buying dollars for toilet paper. But it CAN'T raise rates just now because the sub prime mortgage fiasco, which is, in reality, a much ado but something minor that revolves around mortgage brokers and insurers choosing to ignore the pesky "validating the real risk" part of a bunch of applicants, known as Fraud, and then compounding it by presuming that the American Consumer was anything BUT a whiny bitch.
"But, I didn't know that the 1.0% interest rate was going to go to market rates 3 years in the future", or "I didn't take arithmetic in grade school, so I didn't know that if interest rates went up my monthly payment was going to go up too". Fine. Let's make sure the folks that default or are bailed out NEVER get access to credit again. Let´s put the fraudsters in jail, and let´s get on with our lives. Let's not kill access to debt or credit for those that were poor that dealt with it responsibly.
Sorry... off on a tangent, as I am wont to do. In any case, WHEN fed rates go up, the window for selling at these prices goes down. Today, we live in a historically high oil and gas price environment combined with a historically low interest rate environment. Our window closes when either swing the other way, or, God forbid, both do. That's why it is a good idea to pay just as much attention to interest rates as it is the price of West Texas Intermediate or Henry Hub. I will work on a couple of examples to show you how these swings can affect sales prices for assets. Sorry for such a rambling Saturday morning blog...