Investors See Opportunities in Oil & Gas Market as Big Players Adjust to New Reality

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Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--The Oil & Gas Industry overindulged--again--in the run-up to the crude-oil price collapse that started last summer, and that is creating opportunities for private equity firms and others as the industry is faced with the need to reduce debt, restructure loans, sell assets, and restore its collective balance sheet, speakers here told the 27th Annual Rocky Mountain Energy Summit, held in Denver last week.

Oil & gas companies were overly optimistic when oil prices were high, speakers said at the event, which was organized by the Colorado Oil & Gas Association (COGA) (Denver, Colorado). Many Oil Patch executives seemed to forget that oil is the quintessential global commodity that goes through up cycles and down cycles. When oil fetched more than $100 per barrel, as it did during the summer of 2014, it was easy for those executives to believe that high prices were the new normal, a floor of sorts below which prices would not fall. Companies loaded up on debt and announced ever-greater development plans. Growth was pursued for growth's sake, and because investors rewarded growth. Few people paid attention to costs--and when crude-oil prices began falling, plans started unraveling.

Looking back, "the market was rewarding growth, however economic it might have been," said Claire Farley, a member of Kolhberg Kravis Roberts & Company LP (NYSE:KKR) (New York, New York). "That's over--now companies need to show the economic return of a project. Some companies carried debt that was four or more times EBITDA [earnings before interest, taxes, depreciation and amortization]. That's not sustainable." She was one of several conference speakers who agreed that the industry overindulged amid high prices and forgot the lessons of prior down cycles.

"Two years ago, we wouldn't have be speaking with early-stage companies whose technologies could save operating expenses. because there was so much money in the market that no one cared," Neal Dikeman, a senior venture principal at Shell Technology Ventures LLC (Houston, Texas), told an estimated 1,200 attendees August 26. "The current downturn is accelerating the potential of cost-saving technology." His firm is a unit of Royal Dutch Shell plc (NYSE:RDS.A) (The Hague, Netherlands).

"There is a huge opportunity to put money to work in the industry," said another conference speaker Brad Thielemann, a director at private-equity firm EnCap Investments LP (Houston, Texas). "Cost-cutting is changing the business. Things are painful now, but as an industry we will emerge stronger. We have a lot of dry power and we see a lot of opportunities. We don't want to sit on the sideline--we want to put our money to work. Management's ability to adapt to a changing world is critical. The business conditions you had two or three years ago aren't the same one you face today." EnCap has invested more than $11.5 billion in the Oil & Gas Production and Pipelines industries since its founding in 1988.

Oil & gas companies are expected to go through some turbulence in the coming weeks as executives meet with their bankers in what is known as "borrowing base redetermination meetings," which typically take place in the Autumn. Many oil companies took out asset-backed loans that were secured by the value of their oil in the ground. Loans that were fully collateralized by $100-per-barrel oil are seriously under-collateralized today. Depending on how much of the loan has been drawn down, banks may readjust the terms of the loan, forcing oil companies to either sell assets or partially repay loans.

"Today, 33% of oil & gas companies have debt trading below its face value, ranging from 20 cents on the dollar to 80 cents on the dollar," KKR's Farley told the COGA conference. "This Spring, the industry got lucky and jumped the ditch when crude-oil prices rose right ahead of loan redetermination meetings. But this Autumn, banks and their regulators will be looking at borrowers' overall corporate leverage, as well as asset value for reserve-based loans. They could call a loan if it is under-performing or they could restructure it to reduce their reserve-based lending profile."

"We expect there will be some (investment) opportunities coming this fall as banks revisit loans," EnCap's Thielemann said. "In the right areas, we'd think about doubling down on our existing investments." He specifically mentioned increasing investments in the Permian Basin, the STACK play in Oklahoma, and the Marcellus/Utica shales. "We're looking to invest in those three areas," he told the COGA conference. Shell's Dikeman said his firm would also consider doubling down on existing investments.

"The markets have over-reacted, and that over-reaction has created opportunities," said Bill White, former mayor of Houston and currently chairman of the Houston office of Lazard Limited (NYSE:LAZ) (Hamilton, Bermuda), a financial firm active in debt renegotiations for the Oil & Gas Industry. "In a cyclical industry like oil & gas, leverage is not always your friend," he said August 26. Corporate consolidation "makes some sense in some of the shale plays," he added.

"Most down cycles result in consolidation--that's just the nature of the beast," Shell's Dikeman said. "Right now, the question for the industry is how you grow? Through a merger? Or do you build it organically? If you have a great team, great rocks, great technology and great customers, you can find the cash."

Thielemann predicted there would be a wave of consolidation among public and private companies over the next 12 months. "We're looking to invest in companies with low debt because we don't want banks calling the shots."

Dikeman and Thielemann agreed that the most important asset in today's market is quality management. "If you start with a great team, you can add technology and capital to change the world," Dikeman told attendees. "It all starts with the team." He said his firm has made 12 investments in the last year, slightly more than they would make in a given year. Asked if he would make additional investments in companies that were struggling, Dikeman said, "You don't abandon your children."

Thielemann's final thought to attendees: "Make sure you are capitalized properly. Don't ever run out of cash."

Industrial Info Resources (IIR), with global headquarters in Sugar Land, Texas, five offices in North America and 10 international offices, is the leading provider of global market intelligence specializing in the industrial process, heavy manufacturing and energy markets. Industrial Info's quality-assurance philosophy, the Living Forward Reporting Principle™, provides up-to-the-minute intelligence on what's happening now, while constantly keeping track of future opportunities.