Back in 2015 and 2016, the lows of the oil market provided a painful reeducation of the volatility and whipsaw nature of the energy industry after a period of high prices and ceaseless optimism. Those same lows flushed out some less efficient operators and companies; in their stead came private equity-backed outfits looking to get into the Permian Basin while prices were still relatively low on the bet that oil prices – and consequently asset values – would proceed to march higher going forward. Flipping land and lease deals quickly became the transaction du jour and money poured in on the prospects of quickly multiplying money. For a few years lease and mineral deals seemed to be going that way. At this point, though, most of those easy deals are not being transacted quite as quickly or easily.
On the mineral side, not long ago the model was aggregate a large amount of mineral and royalty interests across a large chunk of the core areas in the Permian Basin, and then cash out to a buyer or buyers who would purchase large amounts across larger swaths of the Midland and Delaware Basins. Now, both E&P companies who choose to acquire minerals as well as institutional mineral/royalty funds are being much more selective about what they acquire and where. There are multiple reasons for this, the main ones being that the wild pace of drilling has been tempered (which slows down when minerals slated to be drilled upon would be producing cash flow), and even that some larger buyers are digesting a series of major acquisitions in the last couple of years. The consequence to private equity outfits is that now more effort will be required to hustle up and sell the acquired minerals; the days of one or a few massive firesales to liquidate large mineral and royalty portfolios would seem to be scant moving forward.
On the leasing side, for some time it had been easy to take some leases and quickly flip them to someone else who would either develop themselves or then pass it on to someone else who would. Blocking up an acreage position was just a function of taking leases strategically and then selling for the right price. Now the model requires more out of the lease reseller – oftentimes developing and proving the viability and value of the lease acreage, and then selling an end-stop buyer more of a turnkey asset. For private equity-backed companies, this represents far more risk and commitment then they may have anticipated going in. A good number of these private equity groups backing short-term acquisition companies probably did not anticipate having to sink millions of dollars into the ground in order to make their assets more attractive, nor the increased risk and potential operational and legal snafus that come along with holding and maintaining an operated asset producing oil and/or gas. This article from last month in the local Midland newspaper touches on these issues well.
So what does this all mean? At the surface level it means the typical amount of time from when a PE-backed company gets its funding to when it finally sheds itself of all of its acquired assets is surely going to increase. There will be more risk and exposure involved, particularly on the leasehold side where buyers in the market looking at a PE-backed company’s assets will insist on seeing wells drilled in order to assess how good the rock is before committing to purchase. These are all manageable issues; the most important factor in all of this is that participants understand that the rules of the private equity game in the Permian Basin are ever-changing.
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