By Rob Sternthal, President, CohnReznick Capital Markets Securities
For the last five years, our team at CohnReznick Capital Markets has focused on providing financial advisory services to stakeholders in the Renewable Energy Sector. Given the several billion dollars in assets that we have thus far financed, we have consistently remained close to the pulse of the market. As a result, we decided, quite naturally, to start a new line of business in the Oil & Gas Sector. That is when, for me, personally, it came as a bit of surprise that I realized I would have to learn an entirely new language.
BOPD, BBL, EUR, PDP, PUD, PDNP, HBP, MCF, TCF, etc. are just some of the acronyms I had to become familiar with in very short order. I’ve spent the last several months not only learning them, but using them with some semblance of comprehension with every potential operator and investor I encountered.
As with all other financial endeavors, the Oil & Gas Sector, too, is seeking yield– but not the conventional yield that is discussed in, say— Renewables. In Renewables, yield is as low as 6-7% unlevered for the best assets, and up to 8-10% for those without investment grade off-takers. In the Oil & Gas Sector, everyone is clamoring for the high teens, low 20’s or a return on capital of 3X – 6X— they want multiples!
Over the last couple years, over $100 billion has been raised to invest in O&G. Currently, it is widely discussed that there are over 230 teams— some operating and some non-operating (passive investors)— looking for deals. Most of these teams are focused on several well-known and developed basins– the Permian, Delaware, Eagle Ford, etc. – where breakeven drilling can be closer to $50/bbl, but only if you already own the acreage. If you don’t own it and want to obtain mineral rights or leaseholds, then you’re probably betting that oil is heading towards $75/bbl or higher.
In the Renewable sector, these “unicorns” are known as Utility-Scale Solar and Wind assets that have Purchase Power Agreements (PPAs— one of a thankfully few renewable acronyms). Every investor is seeking these type of assets and is willing to pay for them to secure a 6-7% unlevered, after-tax return. In the O&G Market, most investors won’t even consider purchasing an asset for less than a mid-teen return, even in a “stretch” scenario where one assumes higher oil prices or lower expenses in the near future.
This is quite an extraordinary scenario, and one that presents a complex series of challenges to Oil & Gas stakeholders. No one seems to have revised their return hurdles– even in light of the following glaring factors that suggest they should:
- Historically speaking, we are at very low Oil & Gas prices.
- Supply of Oil & Gas is going to decrease significantly due to a significantly lower rig count – or less rigs drilling for new oil.
- Significant decline curves for US oil rigs – most new wells will have a precipitous drop in production within the first year.
- The amount of capital seeking new investment plays.
- The amount of foreign direct investment – especially from China.
- Technology for drilling both vertical and horizontal wells has dramatically improved over the last several years.
- The oil service companies that provide rigs and other key, expensive necessities for the O&G market are struggling, making for a great time to lock up lower, long-term drilling contracts.
Yet, despite all of these factors, every investor and/or operator seems to be singing the same tune— namely, we need higher returns due to the high risk of drilling. And then everything they seem to do or say suggests that the drilling risk will be minimized in some fashion or another.
So, here we are, currently at a relative standstill in the market. Sellers won’t sell, and buyers won’t necessarily buy. Is there a middle ground to explore?
I believe we’re about to find out throughout the 3rd and 4th quarters of this year as banks start to squeeze their operator borrowers and as many leaseholders need to avoid expiration. As a long-time veteran of structured finance, I believe that new investors and/or structures will soon appear, if they haven’t already.
If you have interest in this sector and wish to learn about these new structures/vehicles or hire expertise in the market, please feel free to contact us at CohnReznick Capital Markets.