Energy issues have taken center stage this fall, from the widespread power outages in the northeast caused by Hurricane Sandy to the presidential campaign debates about U.S. dependence on foreign oil. Although the topics are mired in controversies, one thing everyone seems to agree on is that the U.S. needs to produce more oil and become more self-sustaining.
"It's fair to say everyone wants energy security, which means reducing reliance on imported oil and gas. The way to do that is by drilling shale deposits that are located all around the country," says Dean Colucci (pictured), president of MLV& Co., a New York-based boutique investment bank. "The technology used to extract oil and gas has gotten a lot better and continues to get better, which makes drilling in the U.S. less risky."
Areas such as the Dakotas, Western Pennsylvania, and Western New York are being drilled horizontally for the first time. "There are more oil and gas resources in the U.S. then what was once thought," adds Colucci. That said, Texas is still where most of the oil companies are located.
Recognizing that working toward energy independence is important to the U.S., companies in the oil and gas sector have been diligently innovating to help find ways for the U.S. to reach its goal. Oil and gas companies have developed a lot of new technology to extracting oil and gas from certain geologic formations an easier proposition. For example, hydraulic fracturing, commonly called "fracking" or "hydrofracking," which creates fractures in rocks by injecting fluid into cracks to force them open, has become more precise and more commonly used. And, while critics of fracking find multiple problems with its use, an assessment by the U.S. Energy Information Administration (EIA) found that there is roughly 750 trillion cubic feet of recoverable shale gas resources in addition to already proven reserves and other known resources, which could meet the U.S. electricity demand for 75 years at current levels of fuel demand.
New technology has allowed companies to drill horizontally into shales, enabling companies to get oil out of rock with much less risk. Historically, when companies drilled for oil and gas, the product they looked for had migrated from the source rock and then got trapped in another formation. Now, thanks to fracking, drillers are able to recover hydrocarbons right from the rock, taking a level of exploration risk out of the equation.
"The improvements made in horizontal drilling and hydrofracking have really revolutionized the oil and gas industry. Virtually every domestic independent E&P company now employs the technologies of horizontal drilling and hydrofracturing, even the little guys. The overall risk profile of oil exploration has changed, because we have shifted to looking for trapped accumulations of hydrocarbons after they migrated out of shales, to capturing the hydrocarbons where they were formed. Because the shales exist over widespread regions, the risk is now more of a technical risk. In other words, will the fracturing break up enough of the rock to recover enough of the oil and/or gas in place to produce a solid economic return? Even with these technical risks there is greater predictability, and this is one reason why the majors, such as Exxon and Conoco Phillips, now have large shale projects in the U.S., and we will continue to see M&A activity in the sector." explains Kim Pacanovsky, a managing director and senior research analyst in the oil and gas sector for MLV.
What's more, the U.S. is way ahead of many other countries in technology developments as they relate to oil production. This has led to a number of foreign firms buying stakes in U.S. drilling companies. In June 2010, Pioneer Natural Resources (NYSE:PXD) signed a joint venture agreement with the U.S. subsidiary of India's Reliance Industries Ltd. (RIL) in a $1.15 billion Eagle Ford Shale deal. Under the agreement, Pioneer sold 45 percent of its interest in Eagle Ford Shale acreage, located in southern Texas, to RIL. The land spans some 212,000 acres.
This was the second major U.S. shale deal that RIL entered into that year. In April 2010, RIL agreed to pay $1.7 billion to form a joint venture with Atlas Energy for 120,000 acres in the Marcellus Shale, which stretches from West Virginia to western New York. In 2011, Anadarko Petroleum Corporation (NYSE: APC) signed a joint-venture agreement with a subsidiary of Korea National Oil Corporation (KNOC), where KNOC will earn approximately one third of Anadarko's interest in the company's Maverick Basin assets, located in southwest Texas, for approximately $1.55 billion.
In October 2012, Oil India Ltd. and Indian Oil Corp. jointly bought a 30 percent stake in Houston-based Carrizo Oil & Gas' Niobrara shale asset in Colorado for $82.5 million. State-run Gail (India) Ltd. acquired a 20 percent stake in Carrizo's Eagle Ford shale acreage last year.
"These foreign firms are trying to gain exposure to the market and learn what we are doing in the U.S." says Pacanovsky. "We are seeing more joint ventures than outright sales, because the U.S. firms don't want to give up their upside, but they need capital to continue exploration."
Not surprisingly, private equity firms, corporations and banks are aware of the intensive capital needs of gas and oil companies, and they are already getting in on the expected surge in U.S. oil and gas production.
In October, MLV opened a new office in Houston in an effort to expand the firm's product offerings in the sector. Bill Conroy was selected to run the office, while Brad Deason and Bill McMackin also work in the Houston office, along with two analysts. Colucci says opening the Houston office was the only move that made sense for the firm at this point in time, given how much of the firm's business is derived from oil and gas companies.
Since the firm's inception in 2010, MLV has completed more than 100 transactions. Approximately 30 percent of the transactions and 50 percent of capital raised by MLV for clients has been in the energy sector. The addition of the Houston office just expands the firm's already burgeoning oil and gas business.
One of the largest product offerings for MLV is at-the-market (ATM) offerings, which enable public companies to sell registered shares at the prevailing market price, at the time and in amounts of its choosing. The price and volume of sales in an ATM are solely determined by the issuer. According to MLV, an ATM is the most efficient method for a public company to raise capital, as it maximizes proceeds and minimizes dilution for an issuer. "If you market a deal where you try to stuff $50 million shares through the market on one day, the stock price drops, and so does the company value," explains Colucci. "This way is much more effective."
The oil and gas business is very capital intensive as a result of the capital expenditures, drilling needs and the regular need to buy acreage to drill. MLV will break up a client's $50 million need into smaller increments and sell it into the market over time, which "has no effect on the stock price and it's less dilutive, while giving more capital to the company's drilling and mining programs," says Colucci.
Oil companies are taking advantage of MLV's ATM offering. For 2010 and 2011, MLV was the market leader, with 20 percent of the marketshare for ATM transactions. When MLV launched its firm, energy transactions made up 30 percent of its business. Now, energy makes up 50 percent of its business.
"The bottom line is that the U.S. is in a positive trajectory to become more energy-independent. There are clear benefits to producing our own oil, rather than to buy it from Mideast nations," says Pacanovsky.
Investment bankers aren't the only firms partaking in the growth in the oil and gas industry. In September, Hastings Equity Partners, a mid-market oil and gas investor focused on deals in the $4 million to $10 million Ebitda range, opened a new office in Houston, which is led by Tanner Moran (pictured), vice president of business development at Hastings.
Hastings' establishment of a Houston office highlights the firm's focus and commitment to investing in the energy services sector. "The center of the energy market is in Houston and, being based in Boston, it's challenging to be involved in the daily activities in the market when you are a four-hour plane ride from the center of the action," say Moran.
Hastings is currently raising its third fund, which has a target of $200 million, and will focus mostly on energy deals. Its last fund raised $60 million in September 2008. Its first foray into the market was in 2005, with a $25 million fund.
Shortly after opening the Houston office, Hastings acquired CP Well Testing, which provides flow-back and well-testing services for oil and gas companies throughout the Granite Wash and Woodford shale plays. Prospect Capital provided senior financing on the deal. Arvest Bank provided working capital financing.
Founded in 2008, CP Well has been folded into Hastings' Fluid Management Holding Platform. Hastings has acquired four companies and placed them under its Fluid Management Holding Platform. The private equity firm made its first acquisition in February 2011 of a Texas-based company that provides fluid transportation services, which injects three to five million gallons of water into a shale to flow the gas. The second company Hastings bought for the platform was in November 2011. This business is also a fluid transportation company located in Oklahoma. The third acquisition for the platform came in May 2012 and was also a fluid transportation business.
"The U.S. has always been one of the largest importers of foreign oil. We have the capability to provide lower energy costs in the U.S., as we have significant domestic resources and should focus on developing them in an environmentally-friendly manner. "
With an office based in Dallas, Wynnchurch Capital has also gotten in on the action in the oil and gas sector. At the beginning of October, the private equity firm made an equity investment in Loadmaster Derrick & Equipment. Loadmaster designs and fabricates derricks, which is a lifting device, or mast, usually seen on offshore oil rigs.
The company's owners co-invested in the transaction and will continue to lead the company.
Wynnchurch was attracted to the deal for many reasons, including that the company is able to fabricate onshore, as well as offshore, derricks and equipment. Additionally, while drilling in the U.S. is becoming more widespread, offshore drilling continues to increase as well. "Loadmaster is heavily concentrated on the offshore drilling equipment industry, which is attractive because it's a global market that can be served from the U.S.," says Dominic LaValle (pictured), a managing director with Wynnchurch. "Offshore drilling activity is increasing on a global basis, and we expect jackup rig construction to increase, because more efficient and safer newbuild rigs can be ordered and constructed, while very old rigs provide their last days of revenues before being scrapped and replaced. Upgrading an old rig is not only expensive but results in lost revenues while it is in the shipyard. Loadmaster provides both upgrades of old rigs and makes equipment on new rigs, so it is positioned either way for an equipment cycle that is just beginning and expected to last at least 15 years.
Indeed, in the late 1970s and early 1980s, hundreds of jackup rigs were built to drill before oil prices collapsed in the 1980s, and rig construction did not resume in a substantial way until 2005. As a result, the global jackup fleet is old and getting older. Rigs get scrapped after 28-32 years. But in 2011, 30 percent of the global fleet was over 30 years old and, despite current newbuild backlog at shipyards, more than 50 percent of the fleet will be over 30 years old by 2015. In addition, dayrates are up at least 30 percent year-to-date, making the ownership of rigs more profitable and likely triggering newbuild orders as old jackups are retired. "Eventually, these jackups need to be replaced or upgraded. I don't know exactly when it will happen, but we do expect an uptick," says LaValle. "With a 20-year record of delivering highly engineered fail-safe equipment on time and on budget, Loadmaster is well positioned to take advantage of this expected growth."