The wheels on the bus go round and round.
1. With $1B of dry powder on the sidelines for about a year now (E&Y), the oil industry is in a paradox that is creating even more opportunities for buyers who are looking for small, under the radar asset deals with an “open borders” policy.
2. With private equity demanding 20%+ annual rates of return, many financial commitments may indeed be beyond the point of no return thereby causing PE to pull commitments…and the wheels on the bus go round and round…
Permian – hottest O&G zip codes, or dangerous bubble?
Source: Laura Freeman, Oil & Gas PE Investing and Reservoir Engineering
It is a very frustrating deal market in O&G overall. Despite the collapse in oil prices from a couple years ago the deal flow is still very slow, the buyer/seller gap has become extremely persistent, there are a lot of people looking to buy and deal valuations seem to be skyrocketing by the day.
Looking at deal activity, we are about 90% down from 2014 and 50% down from 2015 with 4Q16 so far the lowest in three years (BMO A&D Monitor):
There is also mounting pressure from PE to deploy due to large amounts of capital overhang, a lot of which has not been deployed in 1 to 2 years negatively impacting potential returns by the day. See recent E&Y analysis which discusses $971B in dry powder looking for deals.
These factors are leading to:
- Low deal availability
- Large and persistent buyer/seller gap
- Significant capital looking to deploy
- Large amount of capital overhang continuing to sit, creating pressure to deploy soon
- Management teams and companies that have been looking to acquire and haven’t been able to, in some cases for a year now
- Deal “gridlock” with failed sales based on bids received, banks requiring high paydown, etc.
One consequence is that many of the deals that are actually getting transacted are going for very high values. The most active region right now is the Permian Basin and there are a lot of very high value and even high water-mark deals despite the low oil price.
The big question remaining to be seen is whether these values are justified or whether transactions are being pushed higher and higher by use of “comps” that are not truly comparable, creating a dangerous bubble especially for non-diversified buyers in non-core areas.
Not long ago, you often saw US production multiples or amount paid in $/BOE/day somewhere around $30,000 to $40,000/BOEPD. This was reflective of a high price environment and good deal flow in which deals often went for PDP value and very little or no value given to PUDs.
As seen in the BMO A&D monitor the Permian right now is going at $141,524/BOE/day!
Open questions include:
- Is this justified?
- Is it sustainable?
- Can projects generate returns at this entry?
- What are underlying implications on PUD valuations? And lack of risking?
- How “proved” really are the Proved reserves?
- Are we in a bubble where inappropriate comps are inflating prices and being used to financially engineer the models used to determine deal price?