04-11-2016

Fitch: Oil Price Rebound Allows US HY E&P Acreage Consolidation

oil

High yield exploration and production (E&P) companies are consolidating their US shale acreage plays as oil prices have signaled some stabilization since earlier this year, according to Fitch Ratings. Companies executing recent acreage deals include SM Energy, RSP Permian, Oasis Petroleum, Carrizo, and others.

Variance in bid/ask spreads, a closed high yield bond market, tighter bank lending requirements, and depressed equity valuations had hampered attempts to purchase assets. But with spot WTI prices around $50/barrel, supported by fluctuating sentiment on a potential OPEC deal, and investor enthusiasm on the upswing, high yield E&Ps have become proactive, if not aggressive, with regards to size, scale and the price they are willing to pay to consolidate their acreage positions.

Several acreage transactions priced above historical trends were announced over the past few weeks. Fitch believes that with stabilizing oil prices, this trend will continue as companies look for asset acquisitions to increase production more efficiently. Deals announced so far have been partially financed by equity, which should have a credit neutral impact, specifically for Oasis Petroleum and RSP Permian.

There are clear benefits to owning core acreage in a single location as opposed to holding small pieces in multiple plays. First, high yield E&Ps, which are generally higher cost operators on an all-in basis, can harness greater efficiency benefits in continuous or adjacent acreage positions as technological advancements in drilling, completions and production are implemented. Second, in the current cost sensitive environment, high yield E&Ps no longer have the luxury of time to overcome a learning curve while familiarizing themselves with the geological vagaries of a previously unknown play. They can immediately deploy expertise in a known location, harness strong well economics, and generate attractive returns.

The Permian Basin still dominates most of the acreage consolidation transactions due to lower break-even costs, existing infrastructure and multi-stacked plays that respond favorably to horizontal drilling. Earlier in 2016, the average acreage size for Permian deals tracked by Fitch was 14,000 acres, with average consideration of approximately $400 million. Recently announced deals include; SM Energy’s $1.6 billion purchase of 35,700 net acres in the Permian, which will be partially funded by an equity raise as SM is targeting the Permian as its core operating location. RSP Permian’s $2.4 billion deal to acquire two entities that own 41,000 net acres in the Permian is also notable.

Fitch has not only observed a jump in the size of deals, but some activity outside of the Permian Basin such as the Bakken and the Eagle-Ford. Specifically, in a concurrent transaction, SM divested its Bakken assets to Oasis Petroleum, which is acquiring 55,000 net acres from SM in the Williston Basin. Oasis will finance the $785 million SM acreage with an equity offering. Equally strategic is Carrizzo’s purchase of additional Eagle Ford acreage, also funded with equity. However, Fitch’s view is that some valuations are starting to look full, particularly in the Permian, as companies like SM Energy and RSP Permian will pay over $40,000 per acre.

High yield shale focused E&Ps who strategically core up their economic acreage in a credit neutral manner are viewed favorably, all else equal. Given valuations on recent transactions, particularly in the Permian Basin, the ultimate returns from these recent acreage consolidation deals will depend on a solid recovery in oil prices.

Source: Fitch Ratings

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