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."