SB 181 rule writing dampens merger activity

Colorado’s oil and gas industry is struggling. Even with lower development costs compared to other shale deposits across the country, producers in the Denver-Julesburg Basin have been joining forces with other players in the area or selling their assets in the basin to larger U.S. players.

Much of the merger and acquisition activity is being driven by the investment community. Many investors threw money at oil and gas plays across the country expecting high returns that never materialized. Now investors want more accountability for how their dollars are spent.

A recent survey of oil and gas executives by the Fraser Institute, an independent Canadian think-tank, found that Colorado was the last place industry CEOs wanted to invest their money, which “emphasizes the uncertainty around the rulemaking processes we are in the middle of,” said Scott Prestidge, a spokesman for the Colorado Oil & Gas Association.

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He was referring to Senate Bill 181, which was signed into law by Gov. Jared Polis on April 3, 2019, which ensures that oil and gas development and operations in Colorado are regulated in a manner that protects public health, safety, welfare, the environment and wildlife resources.

Megan Castle, a spokesperson for the Colorado Oil & Gas Conservation Commission, which is tasked with implementing rules that support the mandates of SB 181, said that her agency has until July 1, 2020, to complete four rules.

One of the provisions of the bill was that the commission director would develop objective criteria used to guide the permitting process in a manner that is protective of public health, safety and the environment. Because of the rulemaking process, and other factors, drilling permits have dropped.

“There’s more than just the permitting. It’s also the commodity pricing and the local, state, regional, national and global market and commodity pricing that determines whether or not operators may or may not choose to do drilling,” Castle said.

In the Denver-Julesburg basin, the permits being issued are primarily for oil. On the Western slope, the permits are primarily for gas.

Under SB 181, the COGCC is changing from a volunteer commission to a paid commission.

“Having rules in place with a full-time commission will make permitting more predictable,” she said.

COGA’s Prestidge said that out of the dozen or so rulemakings required by SB 181, “each one takes a significant amount of time to discuss before putting policies in place and then more time to implement in the field. In addition to that, there are a couple dozen communities looking at regulations in different ways. Some are making small tweaks. Some are making larger adjustments. Some communities put local moratoria in place. So, I think all of that collectively is a uniquely Colorado story. At least for the investment community right now,” he said. “It won’t be the case in the long run … we’re focused on seeing our way through those rulemaking stages and regulatory stages and trying to get to a place where there is stability and certainty. But, right now, we have an unfinished product that will take time to complete. The survey reflects that uncertainty.”

According to Enverus, an oil and gas SaaS and data analytics company, there were $96 billion of U.S. oil and gas mergers and acquisitions in 2019. That total was “substantially skewed by Occidental’s $57 billion acquisition of Anadarko, which was also the largest deal of the decade and the fourth-largest oil and gas deal ever,” the company found.

Anadarko is the largest player in the Denver-Julesburg Basin. Occidental has said it plans to cut expenditures in the D-J Basin from $1.7 billion in 2019 to $1 billion in 2020 to help pay off its debt.

Most of the mergers and acquisitions last year were focused in the Permian Basin of Texas, including Anadarko’s assets.

In December, Tulsa, Oklahoma-based WPX Energy announced it would purchase Denver-based Felix Energy for $2.5 billion in cash and WPX stock. Felix has 1,500 gross drillable locations that compete with the returns from its existing position in the Permian Basin of Texas.

Doug Swanson, managing partner of EnCap Investments L.P., the private equity company that founded Felix Energy, stated in the acquisition announcement that “the Felix team has worked tirelessly to build what we consider to be a world-class Delaware Basin asset. Given the current market environment, we are strong believers in consolidation and feel that the Felix asset base is a clear strategic fit for WPX.”

Enverus said that the Felix acquisition was notable because it “shows there are still exits available for the ‘built to sell’ model of private equity portfolio companies.”

Andrew Dittmar, senior M&A analyst with Enverus, said that in the last decade, U.S. shale upended global energy markets and transformed the U.S. into a net energy exporter.

“We’re now at an inflection point where shale matures from a growth industry to one that generates dividends and share buybacks for its investors. Completing that transition and setting the stage for the next 10 years will likely require a round of consolidation, and 2020 sets up the needed pieces for this to occur,” he said in his company’s year-end analysis.

He said that what drove corporate consolidation in 2019 and will continue to drive it in 2020 is the industry’s efforts to get more efficient, improve scale and hit pre cash flow metrics they have been hammering for the last two years.

“We didn’t see the bread and butter asset trading that defined deal trading a couple of years ago,” Dittmar said. “That is an outgrowth of the industry scaling back, looking to spend less.”

In the past, most of the oil and gas mergers in the U.S. were larger competitors swooping in and scooping up smaller shale players, but that didn’t happen in 2019. Most of the mergers in 2019 were “mergers of equals or near equals, companies similarly sized, operating in the same basin with duplicated overhead and central structures, competing for acreage and services,” he said. They decided it “would be more efficient and a better deal to roll up and come together as a larger business. No real cash payments. All equity rolled over from one to another.”

Dittmar said that on a macro level, companies operating in shale plays can gain ground-level operational efficiencies as a larger organization.

“Shale is capital intensive, even more so than traditional oil and gas development. You have to constantly bring new wells online to offset the decline rates on existing wells,” Dittmar said. “Shale players don’t have a track record of earning more than they spend. Conventional assets have done that for a long time.”

He said that conventional drilling has its own set of problems, which is why many large players want to have a mix of conventional and shale plays in their portfolio.

Concerns about what is going on in the Middle East have greatly impacted the U.S. oil and gas industry in the past. Currently, “the U.S. finds itself in a very useful position for balancing global commodity prices. U.S. companies can produce a little more or less relatively quickly compared to a lot of places around the world and that helps normalize the market,” said Prestidge. “Buyers now have options, so when there are hostile situations in other parts of the globe, countries can look elsewhere for their energy, which historically was not always the case. That additional market stability has the benefit of reducing global security threats, while also keeping prices low at the pump.”