Finding Capital Goes Beyond 3-D

APPEX Speakers Give Insight

The seismic data show an impressive structural closure in the hundreds of meters … the associated amplitude anomaly may indicate the presence of a world-class gas accumulation.

The prospect is drill-ready. In fact, the prospect has been drill-ready for 12 months.

But despite the surge in global commodity prices, the prospect's sellers are still looking for a dance partner, whether in the form of private equity capital or a joint venture partner.

In August, the prospect's sellers set up shop in one of the nearly 300 booths at the APPEX 2002 conference in Houston to market their prospect.

APPEX 2002 attracted about 2,000 participants, and provided a showcase for a multitude of prospects ranging from small, stratigraphic traps onshore Texas to large, structural closures in the overthrust belts of Peru and Canada.

Sellers, however, were unanimous in their lament: "It's a tough market out there to raise money for deals."

But is this lament based upon reality or perception? Or is there a disconnect between what the financiers are looking for in "winning deals" and what the explorers or sellers are presenting at APPEX?

Equally important, what does the future hold for sellers courting capital?

The answers to the above questions were presented at the APPEX Dealmakers' Conference. Five speakers, representing a broad cross-section of the financial community, outlined the key criteria they use to source capital for domestic and international oil and gas projects:

  • Frank Weisser, managing director of Weisser, Johnson & Co.
  • Brent Bechtol, vice president of EnCap Investments.
  • Amiel David, vice president of Duke Capital Partners.
  • Gregory Moroney, managing director of Deutsche Bank.
  • Jim McBride, managing director of Fleet Boston Financial.

The financiers spoke of the need for seasoned management teams to turn geology and geophysics into quick cash flow, to reduce risk and increase rate of returns. The name of the game has changed during the past year, they said, and the hurdles for oil and gas companies to raise capital have been raised a couple of notches.

And while capital is still available for E&P activities, their message was clear: "Show me the money."

"By any measure, the changes of the last year have been huge," Fleet Boston Financial's Jim McBride said, adding that in the wake of the events of September 11 and the Enron, Arthur Andersen and WorldCom scandals, investment in public markets has evaporated and the mezzanine financing has collapsed.

"As investors have searched for safety and security, they've gone to the bond market," McBride said.

He cited the example of the XLE, the Energy Select Sector Fund; despite the fact that commodity prices were up, the fund was down 21 percent with the overall market.

Image Caption

Capital Sources—Public Equity Transactions
Graphics Source: J. S. Herold Database

Please log in to read the full article

The seismic data show an impressive structural closure in the hundreds of meters … the associated amplitude anomaly may indicate the presence of a world-class gas accumulation.

The prospect is drill-ready. In fact, the prospect has been drill-ready for 12 months.

But despite the surge in global commodity prices, the prospect's sellers are still looking for a dance partner, whether in the form of private equity capital or a joint venture partner.

In August, the prospect's sellers set up shop in one of the nearly 300 booths at the APPEX 2002 conference in Houston to market their prospect.

APPEX 2002 attracted about 2,000 participants, and provided a showcase for a multitude of prospects ranging from small, stratigraphic traps onshore Texas to large, structural closures in the overthrust belts of Peru and Canada.

Sellers, however, were unanimous in their lament: "It's a tough market out there to raise money for deals."

But is this lament based upon reality or perception? Or is there a disconnect between what the financiers are looking for in "winning deals" and what the explorers or sellers are presenting at APPEX?

Equally important, what does the future hold for sellers courting capital?

The answers to the above questions were presented at the APPEX Dealmakers' Conference. Five speakers, representing a broad cross-section of the financial community, outlined the key criteria they use to source capital for domestic and international oil and gas projects:

  • Frank Weisser, managing director of Weisser, Johnson & Co.
  • Brent Bechtol, vice president of EnCap Investments.
  • Amiel David, vice president of Duke Capital Partners.
  • Gregory Moroney, managing director of Deutsche Bank.
  • Jim McBride, managing director of Fleet Boston Financial.

The financiers spoke of the need for seasoned management teams to turn geology and geophysics into quick cash flow, to reduce risk and increase rate of returns. The name of the game has changed during the past year, they said, and the hurdles for oil and gas companies to raise capital have been raised a couple of notches.

And while capital is still available for E&P activities, their message was clear: "Show me the money."

"By any measure, the changes of the last year have been huge," Fleet Boston Financial's Jim McBride said, adding that in the wake of the events of September 11 and the Enron, Arthur Andersen and WorldCom scandals, investment in public markets has evaporated and the mezzanine financing has collapsed.

"As investors have searched for safety and security, they've gone to the bond market," McBride said.

He cited the example of the XLE, the Energy Select Sector Fund; despite the fact that commodity prices were up, the fund was down 21 percent with the overall market.

"The number of IPOs (initial public offerings) is a direct correlation for the investment appetite," McBride continued, pointing to the fact that as of August 2002 only one energy IPO had been successful in the domestic marketplace.

According to McBride, $2.5 billion of capital capacity has been taken out of the mezzanine financing. This financial vehicle has seen significant players exit during the past year — Aquila, Mirant, TWC and Shell Capital.

He remained optimistic, however, that new mezzanine financiers would emerge to fill the void.

McBride's sentiments were echoed by Frank Weisser of Weisser, Johnson & Co., who said "we've suffered the biggest one-time demise of the mezzanine players that we've had in 15 years."

Mezzanine financing, as defined by Weisser, is "senior debt tied to developmental drilling — it's project or corporate-like financing that permits development properties to change hands."

Weisser's firm is busy refinancing companies that were financed last year by mezzanine players who have departed.

"There's certainly a shortage of dollars," Weisser said. "Right now it's tough on almost every front — the public market doesn't exist for all practical purposes, and the banks are being cautious for reasons not even related to E&P risks.

"For small- to mid-size companies, it's about as bad as it's ever been."

According to Brent Bechtol of EnCap Investments, public capital markets for the energy sector — public equity and debt financing — have plummeted from $5.0 billion funded in 1997 to $0.90 billion in 2001.

Acquisitions and Divestments Market

The feeding frenzy of corporate E&P mergers and acquisitions (M&A) in 2000-2001 tracked climbing commodity prices. Despite even higher commodity prices in 2002, the industry has been characterized by corporate retrenching — companies have restructured to shore up balance sheets, and have trimmed budgets.

The steep decline in M&A activities, Weisser said, is the result of companies trying to preserve their existing reserves base and existing production.

Ironically, companies like Williams, Calpine Corporation and El Paso Corporation are busy divesting their recently-acquired upstream- and mid-stream assets.

"These assets are now on the block at a more favorable price than when these companies acquired them," Weisser mused.

'A Sellers' Market'

Bechtol described the current business environment as "a sellers' market."

During the past 12 months, according to Bechtol, some $3.5 billion of private equity capital has become available, including several new funds.

"EnCap's business philosophy," Bechtol said, "has been capital preservation with upside — that is, acquire and exploit." He described providing capital required to move PUDs (Proven Undeveloped Reserves) to PDRs (Proven Developed Reserves). His company's niche is sourcing capital for domestic development activities.

"The lifeblood of our business is backing management teams who are making acquisitions and drilling upsides," Bechtol said. "You're just not buying proven reserves, you're buying a team with a proven track record."

While the financiers acknowledged the fact that E&P companies need to grow through the drill bit, they said that the private equity markets have been historically adverse to pure exploration.

In terms of financing stand-alone, wildcat exploration prospects, the financiers were unanimous in their advice to sellers — look to friends, family and business contacts, or find a joint venture partner.

EnCap, according to Bechtol, finances exploration as one of several elements in a company's portfolio; such a portfolio might include:

  • Daily production.
  • A corporate acquisition for additional reserves.
  • A development drilling program to exploit upside.
  • A separate exploration drilling program.

EnCap might also take economic advantage of a "good promote" in an exploratory prospect.

Bechtol pointed to the emergence of some equity capital sources capable of funding exploratory drilling — Warburg Pincus and Energy Spectrum Capital — who have a greater tolerance or capacity for risk.

The Cost of Capital

The cost of capital varies, according to Amiel David of Duke Capital Partners:

  • Senior lending or debt (usually banks) is one to two percent above the prime lending rate.
  • Mezzanine financing is about 12-17 percent.
  • Equity capital is more than 25 percent.

Bank debt, mezzanine financing and private equity capital are secured by reserves and/or assets. The placement of significant equity capital often guarantees financiers a seat on the company's board of directors.

Duke Capital Partners places private equity capital in start-up companies who engage in exploration activities.

"If you put equity into exploration, you need a rate of return north of 25 percent," David said. "If a company is prudent, it won't borrow money to do exploration, because it's too risky."

From an investor's perspective, David said he looked for several key criteria:

  • A Company must have a track record of keeping its capital expenditures (CapEx) within budget. CapEx overruns, according to David, reduce a company's ability to complete a drilling program and book reserves.
  • He likes to see 60-80 percent of a company's daily production hedged on an annual basis — this guarantees a known cash flow, and demonstrates the company's ability to pay down debt and fund ongoing E&P activities.
  • A company must have an exit strategy — defined over a three- to five-year period — whereby it builds its asset base, adds value and prepares itself for sale or merger.

David described the final criterion in a "winning deal": A company must be willing to take a piece of the action.

"I want them to be at financial risk as well," he said. "This way, they have a vested interest and very strong incentive to be successful when they put their money in."

Not All Created Equal …

"Not all projects are created equal," said Gregory Moroney of Deutsche Bank. "In this particular economic environment, the financing is just as important as the geology and the geophysics."

Moroney outlined how his organization evaluates international projects seeking funding.

He advised that E&P companies — unless they are majors with deep pockets — re-evaluate their strategies of exploring internationally in new basins without any existing infrastructure. He emphasized that only projects with assets or resources that can be sold offshore or "monetized" for hard currency are candidates for capital investment in emerging markets.

"You don't have a company-maker if you can't sell it and convert it to U.S. dollars," Moroney said.

In a case study, Moroney presented how Deutsche Bank took the lead in structuring a $2.5 billion deal to develop the Barracuda and Caratinga offshore oil fields in the Campos Basin of Brazil.

Petroleo Brasileiro S.A. (Petrobras), due to budgetary restraints, could not develop the fields. In a deal negotiated between 1998 and 2000 — one that weathered the devaluation of Brazil's currency — Deutsche Bank created a capital structure that included an offshore holding company that owned the production infrastructure and leased it back to Petrobras.

Mechanisms were in place for lenders to take oil in lieu of cash, if necessary, and to hedge Brazilian production. Financing was comprised of a unique partnership between international public and private financing sources, as well as the first-ever international cooperation between leading providers of Political Risk Insurance (PRI).

"Private equity has a small appetite for going offshore," Moroney said. "Fund managers want to do deals, but the only agencies who have the time and the patience (for international deals) are the World Bank and multi-lateral lenders."

Moroney suggested that E&P companies need to understand how the investment community values — or discounts — an E&P opportunity or asset. For example,the market is discounting the value of Talisman Energy's resource in the Greater Nile Oil Project in Sudan because of the geopolitical risk in the war-torn country. Talisman's 25 percent share nets over 60,000 bbls per day.

Closer to home, Moroney pointed to the 30 Tcf of stranded natural gas in Prudhoe Bay.

"These reserves are not carried on the shareholders' books," Moroney said, "nor will they be given any value by the markets until the Alaskan pipeline is constructed."