What I Like About Texas

Dec 09, 2023

Wednesday, 06/07/2023Published by: Housley Carr

The headwinds facing producers in the Permian, the Eagle Ford and other shale plays are trimming the valuations of oil and gas assets and making it easier for deep-pocketed acquirers and private-equity-backed sellers to reach deals. For proof, look no further than the ongoing frenzy of M&A activity in South and West Texas, where large and medium-size E&Ps alike continue to gobble up smaller producers with complementary assets. Their goals are one and the same: increase scale, improve efficiency, cut costs and build inventory in highly productive plays with easy access to Gulf Coast refineries, fractionation plants, and export docks for oil, LNG and NGLs. In today's RBN blog, we discuss the most significant deals in the Lone Star State so far this spring and what they mean for the acquiring companies.

Sagging hydrocarbon prices, concerns that the best well sites have already been drilled, and prospects for a slowing economy this summer and fall have combined to bring down the valuation of many oil and gas assets in recent months, thereby closing the bid/ask spread and enabling a number of deals to be reached. Just a few weeks ago, in Let's Go Crazy, we looked at Ovintiv's $4.275 billion plan to purchase "substantially all" of the leaseholds and related assets of EnCap Investments’ Black Swan Oil & Gas, PetroLegacy Energy, and Piedra Resources in the Permian's Midland Basin. The deal, which is expected to close later this month, is a biggie for Ovintiv — it will nearly double the company's oil and condensate output in West Texas, lower its per-barrel production costs, and add more than 1,000 well locations to its inventory.

And Ovintiv is far from alone in its multibillion-dollar bid to expand its holdings in Texas. As we said more than a year ago in Buy, Buy, Buy, the upstream oil and gas sector is in the midst of the most impactful wave of corporate consolidation in decades, with many of the deals focused on the Permian — for example, ConocoPhillips acquiring Concho Resources, Cabot Oil & Gas merging with Cimarex Energy to form Coterra Energy, and Pioneer Natural Resources buying Parsley Energy and DoublePoint Energy. In Baby, I’m-A Want You, we focused on the half-dozen Permian-related deals that Earthstone Energy completed to expand its role in both the Midland and Delaware basins. Then, in other Permian-related M&A blogs, we looked at Devon Energy's extensive "portfolio renewal" program (Spread Your Wings), followed by reviews of Diamondback Energy's bolt-on acquisitions of FireBird Energy and Lario Permian (West Texas in My Eye) and Matador Resources’ April 2022 purchase of Advance Energy Partners (Harder, Better, Faster, Stronger).

And don't forget the Eagle Ford. The South Texas shale play may not be the superstar it was a few years ago, when it was duking it out with the Permian and the offshore Gulf of Mexico for the #1 spot in crude oil production and with the then-preeminent Haynesville for top honors in natural gas output, but it's still attracting more than its share of M&A, as we discussed in our Come Back Song blog series.

Today, we discuss the latest round of planned acquisitions in the Permian and Eagle Ford, starting with the recent announcement by Vital Energy and Northern Oil & Gas (NOG) that they will acquire Forge Energy II Delaware LLC's assets in West Texas. Forge Energy II Delaware is yet another EnCap Investments company that assembled desirable acreage in the Permian and then sold it to others — see the Ovintiv/EnCap reference above. (For many years, EnCap has been a leading provider of venture capital to the independent portion of the oil and gas industry.) Under the deal announced May 12, Vital (formerly known as Laredo Petroleum) will acquire a 70% ownership interest in Forge Energy II Delaware's assets in Reeves, Ward and Pecos counties for $378 million in cash and NOG will acquire the remaining 30% stake for $162 million. Vital will operate the assets, which include about 24,000 net acres (orange-shaded area in Figure 1) and 12,900 barrels of oil equivalent per day (12.9 Mboe/d) of production, about two-thirds of it oil.

Figure 1. Vital Energy's Existing and To-Be-Acquired Acreage in the Permian.

Sources: Vital Energy, RBN

The deal, which is expected to close by midyear, will give Vital Energy its first foothold in the Delaware — until now, the company's sole focus has been the Permian's Midland Basin, where the E&P holds about 174,000 net acres (blue-shaded areas in Figure 1) and produces ~87 Mboe/d, 41.5 Mb/d (or 48%) of it oil. The transaction will give Vital and its partner about 100 gross high-value oil locations in the Delaware's second and third Bone Spring benches and Wolfcamp A bench with an average breakeven oil price of about $50/bbl WTI, with potential upside in additional stacked formations.

As for NOG, the Forge Energy II Delaware deal confirms its status as a leading non-operated-focused E&P. Over the past couple of years, NOG has grown dramatically by purchasing packages of non-op assets, often those divested by buyers in larger deals. Its Forge Energy purchase with Vital Energy is the second in which NOG is participating in the original transaction, in effect partially financing the deal by directly acquiring the non-op assets of the seller.

Vital Energy, which operates two rigs on its Midland acreage, said it plans to operate one rig on the Delaware acreage it will be acquiring from Forge Energy II Delaware — one fewer than the current owner. Vital said that running only one rig in the Delaware will keep production levels there relatively flat while maximizing free cash flow, a less-is-more strategy that has been widely adopted in the Permian (and other plays). Vital does not currently pay a dividend; it said it plans to use free cash flow to help pay down debt.

Vital Energy's announcement regarding Forge Energy II Delaware followed Vital's April 2023 acquisition of Driftwood Energy Operating LLC — and its 11,200 net acres and 5.4 Mboe/d of production in the Midland Basin (most of it in Upton County) — for about $120 million in cash and 1.6 million shares of Vital. Driftwood is financially backed by Carnelian Energy Capital Management, a Houston-based investment firm. (Another Carnelian-backed LLC figures in another deal we discuss later.)

Next, we look at the recent announcement by Callon Petroleum to build on its position in the Delaware and also exit the Eagle Ford — moves the E&P said will "streamline and focus [its] operations, accelerate the achievement of its debt reduction target, and allow for the initiation of a shareholder return program" in Q3 2023. Callon said May 3 that it had signed a definitive agreement to acquire Permian-focused Percussion Petroleum Operating II LLC in a cash-and-stock deal valued at about $475 million ($265 million in cash and $210 million in newly issued Callon shares), plus potential contingency payments of up to $62.5 million.

Figure 2. Callon Petroleum's Existing and To-Be-Acquired Acreage in the Delaware Basin.

Sources: Callon Petroleum, RBN

The Percussion Petroleum deal, which is expected to close in July, will add 18,000 net acres (orange and white-and-orange-shaded areas in Figure 2 above) to Callon's current 127,000 net acres in the Delaware (blue-shaded areas), boost the acquirer's production in the basin by 14 Mboe/d (or 15%) from the current 93 Mboe/d, and increase oil's share of Callon's Permian production to 58% from the current 56%. The acquisition also will augment Callon's inventory by providing about 70 high-return oil-drilling locations with proven third Bone Spring and Wolfcamp A and B benches. Callon said that about 90% of Percussion's inventory has a PV10 breakeven of less than $45/bbl WTI. (PV10 is a calculation of the present value of estimated future oil and gas revenues, using a 10% discount rate.)

We should note that Callon Petroleum's planned July acquisition of Percussion follows its October 2021 purchase of Primexx Energy Partners — and its 35,000 net acres and 18 Mboe/d of production in Reeves County — in a cash-and-stock deal valued at $788 million.

Under a separate deal also expected to close in July, Callon Petroleum agreed to sell its Eagle Ford assets to Ridgemar Energy Operating LLC (another E&P backed by Carnelian Energy Capital Management — see Driftwood reference above) for $655 million in cash and potential contingency payments of up to $45 million. The 52,000 net acres and ~16 Mboe/d of production involved in the Callon/Ridgemar transaction are in South Texas's La Salle, McMullen and Atascosa counties (blue-shaded areas in Figure 3.)

Figure 3. Callon Petroleum Acreage in the Eagle Ford Being Sold to Ridgemar Energy.

Sources: Callon Petroleum, RBN

Given that Callon Petroleum's production in the Eagle Ford (~16 Mboe/d) is roughly equal to the ~14 Mboe/d produced by Percussion in the Permian, Callon's pro forma production (after the two deals have closed) is expected to remain steady at about 105 Mboe/d (including 63 Mb/d of oil), all of it in the Permian. But other things will change for Callon — all for the better. For example, the E&P's debt will be reduced to less than $1.9 billion, with a goal of further reductions to $1.5 billion; its per-boe operating costs will be trimmed by about 5%; its decade-plus inventory will be increased to a total of more than 1,500 high-quality locations, all in the Permian; and (as noted) it will be able to initiate a share-buyback program, with a goal of buying back $300 million in shares by Q2 2025.

Ridgemar Operating isn't the only E&P acquiring acreage and production in the Eagle Ford. Crescent Energy said May 2 that it had entered into a definitive agreement to acquire about 75,000 net acres and ~20 Mboe/d of production in the Eagle Ford (mostly in Dimmit, La Salle and Webb counties; red-shaded areas in Figure 4) from Mesquite Energy for $600 million in cash. Crescent already holds a roughly 15% ownership interest in the acreage; the Mesquite deal will increase its stake to about 50% and give it operational control. The deal, which is expected to close in Q3 2023, will boost Crescent's Eagle Ford production by two-thirds (from the current ~30 Mboe/d to about ~50 Mboe/d) and — given that 100% of the assets it is acquiring are currently operated by Mesquite — increase the share of its Eagle Ford production that is operated by Crescent to ~90% from the current 65%. (Mesquite Energy will continue to hold other acreage nearby.)

Figure 4. Crescent Energy's Existing and To-Be-Acquired Acreage in the Eagle Ford.

Sources: Crescent Energy, RBN

Crescent Energy, which is also a leading producer in northeastern Utah's Uinta Basin, said the addition of some of Mesquite Energy's assets in the Eagle Ford will nearly double the company's operated inventory in South Texas. It also said it expected the transaction to be immediately accretive to key per-share metrics, including operating cash flow, free cash flow and net asset value. One further note: This isn't Crescent Energy's first visit to the M&A rodeo. In the 2020-22 period alone, Crescent made a total of 10 acquisitions. It also divested its operating position in the Permian in Q4 2022 for $80 million.

There are a number of other, mostly smaller deals occurring in both the Eagle Ford and the Permian in recent weeks — and recall that Chevron's planned $7.6 billion acquisition of PDC Energy, while focused primarily on PDC's acreage and production in the Denver-Julesburg (DJ) Basin in Colorado, has a Permian angle too. In its own way, each of these acquisitions (and divestitures) reflects the high level of interest that many producers have in Texas. In addition to the vast amount of oil, gas, and NGL resources in the Permian and the Eagle Ford, the two production areas offer pipeline connectivity to hydrocarbon end-users along the Texas coast as well as easy access to export markets, which — as we’ve said in several recent blogs — are becoming increasingly important to producers and midstreamers alike.

"What I Like About Texas" was written by Gary P. Nunn and appears as the ninth song on Nunn's third solo studio album, Home with the Armadillo, released in March 1984. The song, which was released as a single in December 1985, is another treatise of tourism for the state of Texas by Nunn, from mentioning burritos and Lone Star Beer to a geographical tour of several locations in the Lone Star State. Nunn was in fact later designated an Ambassador to the World by Texas Governor Mark White in 1985. His other achievements include a citation from the Oklahoma House of Representatives, an award of appreciation from the city of San Antonio, membership in the Texas Hall of Fame, and being named a musical ambassador for Texas by Texas Governor Rick Perry in 2007.

Nunn is best known as the writer of "London Homesick Blues (Home with the Armadillo)," which was made famous by Jerry Jeff Walker and used as the theme song music for Austin City Limits from 1977 to 2004. Jerry Jeff Walker also recorded "What I Like About Texas" and it appears as the seventh song on his 25th studio album, Viva Luckenbach! released in 1994. Personnel on Nunn's version of "What I Like About Texas" were: Gary P. Nunn (lead vocals, guitar), Rick Fowler (bass), Tommy Howard (drums), Junior Brown (lead guitar), Herb Steiner (pedal steel guitar), and Sarah K. Woolridge (backing vocals). The album was produced by Michelle Termohlen and Murray Mead.

Gary P. Nunn is an American country music singer-songwriter. He has released six albums with the Lost Gonzo Band and 19 albums as a solo artist. He currently runs an 800-acre cattle ranch in Oklahoma and continues to occasionally perform live.

Jerry Jeff Walker was an American country music singer-songwriter. He released 38 albums and 13 singles. He was known as one of the originators of progressive country music and the outlaw country movement out of Austin, TX. Walker died in October 2020 at the age of 78.