American Oil and Gas Reporter - April 2018 - 66

VISION2020
POWERED BY PRIVATE EQUITY

private equity firms placed $12.4 billion
Q: inIn 2017,
commitments to 73 new U.S. oil and gas
startups, and participated in some $30 billion worth of
upstream merger and acquisition deals (private equity
went from accounting for 10 percent of the acquisition
market in 2010 to 48 percent last year). Of course,
private equity also continues to invest billions of dollars
annually in midstream infrastructure build-out. Do you
see the historically strong inflows of private equity into
the U.S. upstream continuing through 2020? As a
private equity investor, how do you assess the opportunity
sets going forward in U.S. basins?

VANLOH: It is an interesting question, and while we do not
have a crystal ball, we do think there are some interesting
trends hidden in the acquisition numbers. Year over year, acquisition activity from public companies fell by almost 30 percent
while private equity acquisition activity remained relatively
flat. In 2017, more than 80 percent of public company acquisition
dollars were directed toward the Delaware, Midland or Appalachian
basins. Sentiment among public investors is undoubtedly
strongest in those basins, and consequently, the capital markets
were selectively open for well-capitalized public companies to
add economic core inventory, usually through the acquisition of
assets held by private equity-backed companies.
Outside of those basins, however, where public investor sentiment is weaker, a trend is emerging that we believe will play
out over the next several years. The "pledge" of public companies
to live within cash flow and divest noncore inventory is creating
interesting opportunities for private equity to acquire assets at
attractive valuations and apply leading-edge technologies and
operational excellence to generate returns. Private equity shared
the driver's seat with public companies during the exploration
and delineation of many of today's most economic resource
plays-Delaware Basin, Midland Basin, Marcellus/Utica,
SCOOP/STACK, Eagle Ford, and others -and private entrepreneurs
have developed a deep understanding of how to apply leadingedge technologies to enhance the commercial viability of unconventional resources.
This emerging trend can be seen in the 2017 acquisition
activity figures. Private equity accounted for more than 80
percent of acquisition activity outside of the Delaware, Midland
and Appalachian basins and accounted for more than 90 percent
of acquisition activity in areas such as the Rockies, Eagle Ford
and Haynesville.
In addition, a third of the horizontal rigs currently running in
these "out of favor" basins are attributable to private equitybacked companies. With more than $200 billion of energyfocused private capital raised since 2010-almost $140 billion
of which was raised between 2014 and 2017-we believe private
equity-backed companies are well positioned and adequately
capitalized to execute on the opportunity set.
66 THE AMERICAN OIL & GAS REPORTER

You have noted that the unconventional revolution
Q: fundamentally
has changed the scale and capital
intensity of the domestic industry. In what ways, specifically, has resource play development changed the
game for oil and gas companies? How has this new
competitive landscape altered capital formation strategies
and redefined the model for private equity success?
What does that imply about how operators will capitalize
their resource play development projects and operations
going forward?

VANLOH: To understand how dramatically unconventional
resources have reshaped the North American oil and gas
landscape, one can simply zoom in on a "section" of land (one
square mile, or 640 acres) in the Midland Basin. Prior to the unconventional revolution, this single section of land might be
fully developed with eight vertical wellbores for about $16
million and deliver almost 1 million barrels of oil. Now, that
same section of land might be developed with more than 50
horizontal wellbores across seven (or more) distinct stacked
formations, requiring about $280 million of investment and delivering almost 30 million barrels of oil.
Said differently, an 18-times increase in invested capital
generates nearly a 30-fold increase in recovered resources,
implying a greater than 40 percent decrease in finding and development costs per barrel of oil.
In the early innings of the unconventional revolution, a lesscapital intensive business model centered on greenfield leasing
and moderate delineation drilling was employed by private equity-backed companies with great success. Today, however, as
we move into the middle innings of the unconventional revolution,
the window to employ that strategy largely has closed. Going
forward, private equity-backed companies must be prepared to
drill more wells to de-risk an asset and cross the threshold into
positive free cash flow before it is sold. This will require longer
holding periods and substantially more capital.
Management teams need to build great technical staffs
capable of excelling operationally and implement conservative
financial principles (modest leverage and longer tenured hedges)
to ensure they have durable business models that can withstand
commodity cycles. Management teams need to align with
sponsors that can invest larger amounts of equity and are
committed to longer holding periods. Private equity funds also
will need to be open to deploying capital into less-traditional
structures. While line-of-equity commitments to startup management teams will continue, recapitalizations of existing companies, preferred equity investments, private investments in
public equities (PIPEs), asset-level joint ventures and so-called
drillco structures will become increasingly common and should
present attractive investment opportunities.
As the unconventional revolution enters a more mature
phase, the keys to successful private equity investing will remain
unchanged. Prudent capital allocation decisions, technical and
operational excellence, conservative use of debt, aggressive



American Oil and Gas Reporter - April 2018

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