It is a very frustrating deal market in O&G overall. Despite the collapse in oil prices from a couple years ago the deal flow is still very slow, the buyer/seller gap has become extremely persistent, there are a lot of people looking to buy and deal valuations seem to be skyrocketing by the day.
Looking at deal activity, we are about 90 percent down from 2014 and 50 percent down from 2015 with 4Q16 so far the lowest in three years (BMO A&D Monitor):
(Click to enlarge)
There is also mounting pressure from PE to deploy due to large amounts of capital overhang, a lot of which has not been deployed in 1 to 2 years, negatively impacting potential returns by the day. See recent E&Y analysis which discusses $971 billion in dry powder looking for deals.
These factors are leading to:
• Low deal availability
• A large and persistent buyer/seller gap
• Significant capital looking to deploy
• A large amount of capital overhang continuing to sit, creating pressure to deploy soon
• Management teams and companies that have been looking to acquire and haven't been able to, in some cases for a year now
• Deal "gridlock" with failed sales based on bids received, banks requiring high paydown, etc.
One consequence is that many of the deals that are actually getting transacted are going for very high values. The most active region right now is the Permian Basin and there are a lot of very high value and even high water-mark deals despite the low oil price. Related: Saudi Arabia Surrenders To U.S. Shale
The big question remaining to be seen is whether these values are justified or whether transactions are being pushed higher and higher by use of "comps" that are not truly comparable, creating a dangerous bubble, especially for non-diversified buyers in non-core areas.
Not long ago, you often saw U.S. production multiples or amount paid in $/BOE/day somewhere around $30,000 to $40,000/BOEPD. This was reflective of a high price environment and good deal flow in which deals often went for PDP value and very little or no value was given to PUDs.
As seen in the BMO A&D monitor the Permian right now is going at $141,524/BOE/day!
Open questions include:
• Is this justified?
• Is it sustainable?
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• Can projects generate returns at this entry?
• What are underlying implications on PUD valuations? And lack of risking?
• How "proved" really are the Proved reserves?
• Are we in a bubble where inappropriate comps are inflating prices and being used to financially engineer the models used to determine deal price?
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The Permian completed deals have been weighted toward strategic with a large percentage of deals forced to pay down secured in other basins.
The problem is that the natural buyers for these fattened calves will be foreign, but since the next price spike will likely happen in the Presidents first term who knows if such deals will go through. You can bet the supers are not going to bid up the oxy's. Thus this food chain in disrupted and pe's are not going to gamble on commodity prices that have shown upwards of 1000% intra annual vol.
The next big deal with the super majors will likely be with the Waha partners since plan A doesn't seem to be working out, and they will be able to get their hands on Permian, stack, eagle ford or bakken in some combination. But really, nobody has the balance sheet or lack of acreage to spend 10s of billions for 5 extra irr points, especially when you can partner with a government on millions of acres with hundreds of k of barrels ready to flow up to nearly a million.
On top of that, the irr's will likely equalize in the bakken with the bottom line kick of the new pipe when the mess clears. So yea, would I sell call on and buy Hess or marathon. Maybe, but there sure is a lot of dumb money lying around to sleep well. What I do know is that traders will switch lanes without notice and you can hide at .5 book, not 4x book. After all it's the same commodity, just different rock and capital structure with a little government on top.