Good news for exploration:
There’s a lot of outside capital looking for investment opportunities in oil and gas.
Bad news for capital:
Today, it’s not easy knowing where and how to invest in the oil and gas industry.
G. Warfield “Skip” Hobbs is managing partner of Ammonite Resources in New Canaan, Conn., where he has experience and expertise in both worlds.
Hobbs, an Honorary AAPG member and past Association secretary, serves as a consulting intermediary between institutional capital and emerging investment opportunities in the energy industry.
He said most fund managers and institutional investors now consider oil and gas an essential part of their portfolios. Investing in the industry brings some protection against both inflation and higher future energy prices.
“If you are a fund manager, you want to allocate a portion of that fund to exposureto natural resources,” Hobbs noted.
“You want to hold oil,” he said. “And maybe that’s one of the reasons so many people were buying futures” last year.
Big investors tend to be conservative in capital deployment and look for steady but not necessarily spectacular returns, according to Hobbs.
“There’s always the lure of the home run, but that’s not why institutional investors invest,” he said. “As one of my investment clients puts it, ‘You want to invest in those guys who continually get on first and second.’”
Hobbs identified several current areas of interest for institutions that want to invest capital to invest in oil and gas.
“We’re seeing a number of our clients look at alternative energy, particularly geothermal. We’ve had clients looking at heavy oil,” Hobbs said.
But “right now,” he added, “I’d say most of the capital is risk-adverse and is looking at resource plays.”
Shale, International Lures
Shale gas exploration and development is still a happening part of the industry. The catch is, it’s been happening for a while.
“I think the smart money likes to get into these shale plays early, and right now it’s hard to get into a shale play early,” Hobbs noted.
So capital is targeting experienced firms with good track records that hold positions in the best shale plays.
“You’re seeing institutional money come into backing companies that already have the leasehold resources,” Hobbs said.
One emerging opportunity could be in providing funds for management teams that acquire shale-play assets from small, over-leveraged independents.
In the Marcellus Shale play in the eastern United States, wells are going to cost $3 million to $4 million each, “and small companies just don’t have that kind of capital,” he observed.
“Another thing we’ve been seeing is tremendous interest in international,” Hobbs said, including investments in Africa, Asia and elsewhere.
His Kuwaiti clients “see tremendous opportunity for well-capitalized small independents in the Middle East.” Those would be home-grown companies, Arab independents with international financial backing, he said.
If that trend spreads, the importance and influence of non-U.S., non-Canadian independents could be a major story for the industry.
Hobbs said he sees some interest in Latin America, by Canadians and others, “but a lot of political problems (are) there.” Investors are “a little bit gun-shy” of Canada itself because of lower natural gas prices, he added.
Oil sands projects still hold promise but capital is wary of their economic viability, Hobbs noted.
“The cost of material and labor went up because there were a dozen projects going on at the same time. It was just crazy,” he said.
In his speeches about the future of the oil industry, “what I talk about is the resources that are out there globally – and we have plenty of resources,” Hobbs said.
Recent industry woes have arisen more from infrastructure problems and geopolitics, he believes, and investment is needed to address infrastructure needs.
For institutional capital, “there are some huge midstream opportunities,” he observed.
As one example, “you have a lot of pipelines through the Marcellus area, but they’re all at capacity,” he said.
Capital investment by the oil and gas industry itself has declined with falling prices for production, leading to reduced activity – but also to somewhat lower costs.
Michelle Foss serves as chief energy economist for the Bureau of Economic Geology at the University of Texas and head of the Center for Energy Economics in Houston. She tracks how and where the industry deploys its capital.
“The majority of energy investment around the world is coming from the oil and gas industry,” she said. “And that shouldn’t be a big surprise.”
It’s probably also no surprise that the industry invests most of its capital in familiar, bread-and-butter areas and fairly little in experimental or alternative energy projects.
“Much of their investment is going back into their core business, because that’s where they have their competitive advantage,” Foss observed.
“Those patterns are well established and they aren’t going to change very much,” she said.
A contemporary twist on that story comes from the amount of money going into developing and prolonging production from known energy assets. Companies need to get all they can from what they have “as their more traditional oil and gas resources mature,” according to Foss.
“A lot of capital is going into the technology they need to better develop their resources,” she said.
For the global oil industry, today’s biggest resource-play story might be the expansion of interest outside of the United States and Canada.
“People are looking at gas shales all over the place,” Foss said. “We’ve been hearing bits and pieces of news. Exxon Mobil is looking at shale gas plays in Europe, BG is looking in Asia, and whatever.”
Exploration and development work offshore continues to soak up capital, as those projects are less influenced by year-to-year price swings. They also tend to be oil-driven and oil prices are still reasonably attractive, she said.
“Offshore, people are there for a longer period, 10 to 15 years’ development time. It’s sort of a different ballgame,” Foss noted.
High costs and questionable economics have made the industry shy away from ultra-heavy oil and oil sands projects – but the potential of heavy oil is too large for the industry to ignore.
“They need to figure out how to pursue that hydrocarbon source with a lower cost structure. They’ve also had to endure a lot of criticism on the environmental side,” Foss observed.
“People aren’t just going to walk away from that – it’s too big. And that extends to heavy oil plays all over the place,” she said.
Another, sometimes overlooked story is the industry’s increased commitment to investing in people.
“One of the prevailing things is, in spite of the lower gas prices, they are really trying to hold on to their people,” Foss said. “Companies are really trying to keep their employees through this cycle.”
Dealing With Volatility
In anyone’s list of investment risks in oil and gas, price volatility and price uncertainty would have to be close to the top. Oil prices have soared, collapsed and then doubled just in the past 18 months. Natural gas prices have produced a boom and then a bust in U.S. drilling.
“If you asked me right now, ‘Where are gas prices going?’ I would have to say I really don’t know,” Hobbs said.
He identified two likely scenarios for natural gas prices, leading to opposite results.
“We’ve seen a 50 percent decline in drilling – or more –in an industry that has a very high decline ratio. When the economy comes back, the gas won’t be there,” Hobbs said.
“The price could spike right up because of the decline in drilling. But the flip side is that these shale gas plays have tremendous production potential,” leading to a supply surplus and a depressed gas price, he said.
Foss thinks the industry will have to adapt to a low-to-medium natural gas price environment.
“It’s kind of hard to see how you get gas above $6 unless you have a lot of things going on,” she said.
In the future, the emphasis in shale plays will be developing production without as many wells and as much capital investment, according to Foss.
“I would be surprised if the drilling rig count is going to be as high as it was before. People are really going to try to optimize that development without drilling so many wells,” she said.
The direction of oil prices is anyone’s guess. Hobbs predicted a demand rebound and a price jump.
“I think Asian demand is going to go up sharply and we’ll have another price spike,” he said. “You can’t turn off the Asian engine.”
For the future, investment could be looking to new unconventional opportunities. Foss believes more and more capital will be directed toward the potential of nano permeability and nano-porosity in complex reservoirs. It could dwarf the potential of shales.
“I think that’s where a lot of this is going, if people can crack that nut,” she said. “It’s incredible to think about.”
In the near-term, history matters.
Right now, capital is looking for a safe harbor. Institutional investors want a good industry position, a seasoned management team, a history of success.
“The bottom line is having a proven, successful management team that knows how to explore successfully, and the opportunities will fall out. The bottom line is, right now there’s a lot of capital looking at proven management teams.”