[Editor's note: A version of this story appears in the September 2018 edition of Oil and Gas Investor. Subscribe to the magazine here.]

After a strong first six months of recovering oil prices and impressive E&P performance, the blot on 2018’s oil and gas landscape—a flagging A&D market—is hard to take in without an involuntary, karmic sigh.

In the three-year price downturn, the saving grace amid plunging values was the idyllic transactions of the Permian Basin.

Dealmakers spewed billions of dollars over West Texas and New Mexico like a defiant blowout of cashier’s checks. Now, the deal rooms of the Midland and Delaware basins are comparatively quiet while oil prices have, with ups and downs, risen roughly 60% since January.

Through June, the relative boon of deal activity in the Eagle Ford Shale and, to a lesser extent, the Williston Basin, has received outsized attention, largely because of the Permian’s receding grandeur.

Through the second quarter, A&D transactions have nibbled at about $15 billion in value, according to Art Krasny, a managing director at Wells Fargo Securities.

“That’s certainly a modest pace,” Krasny told Investor, noting that first-half 2017 saw asset transactions worth $24 billion.

“We’re down year-over-year and will need to see an acceleration in the second part of this year to catch up with an already modest A&D market of 2017. It’s not impossible, but every day it’s a tougher goal to accomplish,” he said.

The story of the first half, one that is likely to carry over through December, is that investors’ sentiment has trickled into the behavior of public companies down through the asset markets.

At the heart of that sentiment: a lack of confidence. However, advisors and analysts say the deal ecosphere is neither dead, dormant nor even hibernating. Rather, companies are playing it safe, doing their homework on assets and lying in wait.

Until then, E&Ps large and small are treading lightly amid a jittery market. The Permian’s one-off corporate merger—the $9.5-billion Concho Resources Inc.-RSP Permian merger that closed in July—was a seemingly suitable marriage contested by unhappy investors. The day the deal was announced in March the market sandblasted nearly 9% off Concho’s (NYSE: CXO) share price in a single day.

Even private equity’s appetite for deal-making appears to have “tapered,” according to PwC. In the second quarter, both the number of deals and total value hit their lowest levels in several quarters, PwC said in a July 26 report. Financial investors are also remaining on the sidelines without a robust effort to back management teams with equity commitments.

“I think everybody was really beat up and the memories are still there of the blood and carnage of 2015 and 2016,” Brian Williams, a partner at Carl Marks Advisors, an investment banking and corporate restructuring firm, told Investor.

The extreme backwardation of oil prices has also left investors spooked.

“You’ve got high $60 to $70 oil today. If you go out a couple years you’re down to the low to mid-$50s,” Williams said. “It’s a very odd circumstance to be that heavily backwardated.”

That perception is reinforced by companies’ concentration on areas in which breakeven prices are still in the mid-$50 range.

“Nobody’s going to really stretch out, do something bold and take on a bunch of debt to go buy something when they’ve got enough opportunity to do what they’re doing today, and do just fine by shareholders,” Williams said. “That’s what’s out in play right now.”

But most deal advisory companies don’t think things have slowed down. Buyers and sellers are in different stages of deal-making, but with an eye toward being selective.

“There’s an unprecedented number of groups looking to make acquisitions,” said B.J. Brandenberger, a partner at TenOaks Energy Advisors. “On assets with larger PDP components they’re paying closer attention to the low-hanging fruit upside, including operating expense reduction opportunities and higher impact PDNP projects.”

Minerals deals have also become an increasingly meaningful portion of TenOaks’ business, despite the perception—wrongly, Brandenberger said—that the market is softening. Two of the top 10 second-quarter 2018 acquisitions, by Cox Oil and Kimbell Royalty—were for royalty interests with a combined price tag of nearly $1.3 billion.

“We’re not seeing that [decline]. The market has been saturated with deal flow, especially in the Permian” he said of minerals deals. “Some of these mineral deals are … requiring considerably more hand-holding with our buyer universe to keep them focused because their deal flow is so robust.”

Storm Chasers

Dust devils appear in unexpected places—whipping through an Illinois Little League game, a playground in France, and they have even been observed on the surface of Mars by NASA.

In West Texas and New Mexico, however, they aren’t so much curiosities as hazards. The Permian is habitually beset by dust storms. In 2014, one pushed up a 1,000-foot tall column of dust. More recently, a haboob in May and in April roiled Midland, Texas, rattling the airport and smothering the city.

Those storms pass quickly. What hasn’t blown over is thundering from investors who expect a focus on capital discipline, particularly in the Permian Basin region. Companies’ barometers are attuned to changes in investor pressure, and many are reluctant to make a deal until they see fair skies again.

However, other companies are preparing for a rebound in confidence to match the rebound in oil prices. Groups are actively targeting areas that could yield rich returns. For now, however, they are biding their time.

A&D activity in the Midland and Delaware basins has continued to slow. In 2016, Delaware deal values totaled roughly $18 billion, Krasny said. In 2017, that dropped to $15 billion. So far in 2018, the total is $1.7 billion. Krasny’s estimates include asset deals of at least $25 million in value but do not include corporate transactions such as the Concho-RSP deal.

“The slowdown is unmistakable,” he said, “and is caused by general market conditions and the fact that asset consolidation in the core has largely occurred, while corporate M&A will take time to materialize.”

Unless the public markets open up, aggregating acreage is likely to be a challenge in the heart of the Permian, Brandenberger said.

Buying groups have indicated that they’re still trying to find a way in. The pressure to be in the Permian is real, but in today’s market it’s much easier said than done.

Some companies—particularly private-equity operators—are “working to test the outer limits” by prospecting on what is perceived as the edges of the Permian.

For example, some are extending into the shallower portions of the western Delaware into northern Lea and Eddy counties, N.M., utilizing operational learnings from core areas of the basin. They are also applying these practices on the Northwest Shelf and revitalizing the Yeso/Abo trends.

“That same economic core extension principal applies to the Midland Basin. For example, you see companies playing the southern Midland Basin, like in southern Upton, Reagan counties,” he said. “And we are seeing encouraging results, too.”

In part, that’s through applying modern completions, geo-steering and homing in on particular target intervals.

While the geologic core of the Delaware and Midland basins have likely largely been consolidated, some asset opportunities are still available. As technology advances, the economic core of the basin is expanding to redefine prior conventions and asset values, Krasny said.

“Several acreage positions represent a consolidation play in the southern Midland Basin,” Krasny said. “As it takes time for the value proposition of the expanded economic core to manifest itself, some players will be able to harvest the value arbitrage.”

Krasny said the Permian continues to be recognized by market investors as a premium play, providing a tailwind to strategic buyers with Permian positions. However, recent capacity constraints and price differentials have lifted activity.

E&Ps with a presence in the Permian only increase a company’s strength. Krasny said there’s a recognition that while the Permian isn’t absolutely essential to success, large-cap E&Ps with a presence there only increase their company’s strength.

“There’s definitely that pull to be in the Permian,” Krasny said. “There is a necessity. A number of companies are seeking to augment their portfolios with a higher-return crude play, but the timing for such M&A decisions remains challenging. Investors continue to reward pure plays and focused basin strategies, which makes decisions very difficult.”

Seeking Permian Alternatives

While facing struggles in the Permian with an A&D crackdown, high differentials and grimacing investors, E&Ps in the Eagle Ford and Williston Basin have crawled out of the downturn wreckage and restarted operations.

Likewise, the Rockies seem to be commanding more attention as groups seek to find other economic areas outside of the Permian with a lower barrier to entry and where they can apply modern completion techniques, Brandenberger said.

In the Eagle Ford, the $2.67-billion acquisition of EnerVest Ltd.’s assets by TPG Pace to form Magnolia Oil & Gas Corp. (NYSE: MGY) brings a pure-play Eagle Ford story back into focus for public investors, Krasny said.

Technology used in the Eagle Ford has also caught up with the most advanced generation of completions. “We’ve seen rebalancing of rig activity with capital being diverted into the Eagle Ford and other plays that currently enjoy a more attractive price differential and also benefit from new-gen completions,” he said.

Eagle Ford-marketed assets continue to draw attention, Brandenberger said.

“You still have a significant private-equity presence in the Eagle Ford,” he said. “A lot of guys still think they can do really well out there. The returns are there and the play has come a long way.”

Led by a $765-million acquisition by Venado Oil & Gas Corp. in February for Cabot Oil & Gas Corp.’s (NYSE: COG) 74,500-acre position, the South Texas shale had made a strong case for the No. 2 play in the nation.

First-half deals either announced or closed in the Eagle Ford totaled about $5.1 billion, according to data collected by Investor and BMO Capital Markets.

Many E&Ps have exited the Eagle Ford or shifted their focus and efforts to the Permian.

“They’ve let the Eagle Ford languish, and I think you’ll see some people rotate back into there,” Williams said.

Krasny said that as the Permian started to heat up, private-equity firms began to focus on alternative plays with exposure to crude and liquids, including the Eagle Ford, Williston and Powder River basins.

As with the Permian, some companies have taken to the hinterlands. In December, Endeavor Natural Gas LP purchased Hugh Fitzsimmons Field from BlackBrush Oil & Gas LP, which included 48,800 net acres of leasehold and 1,800 barrels of oil equivalent per day of operated production.

“We’re right on the edge of all of the Eagle Ford development,” said Thad Bay, a geologist at Endeavor. The company has since had strong 30-day IP results on multiple new wells.

“These wells are really cheap, running in the $2- to $2.3-million range, so the economics on these are pretty great,” he said.

Endeavor holds about 127,000 gross acres under lease. “At this point it’s a pretty niche play, but it still covers a massive area,” he said.

Stragglers

The Bakken Shale has taken on a different shape, with a few deals to begin the year rapidly snowballing through mid-July. In the first half, 12 deals totaling $1.4 billion were announced or closed. In the first three weeks of July, three more deals totaling $290 million were announced.

Brandenberger said the economics in the Bakken are noteworthy, though some public companies aren’t getting as much credit from investors for their Williston Basin value creation.

Nevertheless, some companies want into the Bakken, particularly as new completion techniques up the ante in North Dakota.

“Recent well results are compelling,” he said. “Bakken assets have been transacting. Selling nonoperated working interests in the Bakken has also been a recurring theme with a seemingly high closing rate and attractive valuations.

Northern Oil & Gas Inc. (AMEX: NOG), for instance, said in July it would purchase nonop producing assets from Pivotal Petroleum Partners for $152 million.

Northern CFO Nicholas O’Grady said the Bakken appears to be landlocked to buyers but, he argues it’s still in the middle of its life cycle with a health amount of inventory.

“The Williston is hard to be beat economically right now,” O’Grady told Investor. “We have participated in over 2,500 wells in the basin, a dataset which gives us a tremendous informational edge.”

The basin also offers appealing economics. In 2014, for instance, wells cost about $10 million and produced 500,000 barrel EURs. “Now the same well costs $7- to $8 million and has a 750,000 barrel EUR, and comes online faster,” he said.

Sellers And Orphans

On balance, Krasny is cautiously optimistic about A&D in 2018’s second half and beyond. Tighter markets and stronger crude prices should cause investor sentiment to improve.

The tough call to make is the timing, he said. “We’re seeing a gradual return of investors into the space, and I expect that trend to continue and ultimately result in a stronger asset market.”

However, it’s clear that the time is not now.

“Windows come and go, and a number of players out there are prepping a process, getting ready to go should the market conditions improve,” he said.

The BHP Billiton Ltd. (NYSE: BHP) asset sale had attracted widespread attention, particularly for its 100,000 Delaware acres.

“Windows of opportunity come and go, and a number of players out there are preparing to enter the market should conditions improve,” he said.

Krasny said he sees the BHP sale as potentially energizing the market, particularly in “plays of relevance.” (At press time, BHP announced its long-awaited shale divestitures to BP and Merit Energy for $10.8 billion.)

“With all of the interest, capital and effort invested in pursuit of the BHP process, unsatisfied demand will look for opportunities to acquire other assets and secure alternative opportunities,” he said.

“With an emphasis on focused development and capital efficiency, we expect to see continued portfolio optimization by strategic players, as well, that will drive assets to market,” he said.

“Topical deals currently in the market include Southwestern Energy [Co.]’s ongoing divestiture of its Fayetteville asset, Pioneer Natural Resource Co.’s Eagle Ford divestiture and QEP Resource Inc.’s Bakken sale, among others. A number of sizeable assets currently in the market should create positive momentum once deals are announced.” (Editor’s note: In late July, QEP said its Bakken sale did not bring forth the bids it anticipated.)

“Keep an eye on the Powder River Basin,” he said. “We’re seeing the deal pipeline continue to build in that area. We continue to see acquisitions by private companies in the basin that will to pave the way for further deal activity. Although it has been hampered by the general market softness, there’s certainly potential building in this oil play.”

On the opposite end of the asset demand are what Williams calls “orphaned assets” in which companies survived bankruptcy but lack premier acreage.

“They’re in a position where their balance sheet stays functional, but in the E&P world if you’re not growing, you’re dying. You’re slowly bleeding to death,” he said.

Those stranded companies have been cast aside as the focus has been on the high-end shale plays.

“I think that’s one of the things that’s changed, is you’ve got people that have the better assets that are winning. People that don’t … are kind of in purgatory, and they’re just hoping for an even better turn in commodity prices,” he said.

Williams is also struck by the interest in natural gas. Ascent Resource LLC’s quadruple Utica buys—four deals totaling about $1.5 billion—seemed to come out of nowhere. Natural gas prices haven’t made stunning gains, but the same efficiencies deployed in the Permian have increased the cost-effectiveness and productivity of gas plays.

The Ascent transactions were large enough to raise the share of gas-focused deal values to 28% in the second quarter of 2018—the highest share of value since second-quarter 2017, according to Drillinginfo Inc.

Williams mused that after 20 years in the industry, he’s either seen gas or oil A&D booms.

“We haven’t’ had both hit at the same time and it’s kind of the law of averages that at some point you’re going to have strong activity in both of those commodities,” he said. “That’s going to put some interesting pressures on the U.S. oil and gas industry service providers and, subsequently, the service side.”

Williams sees the rest of the year mirroring the first half, though he wouldn’t be surprised by another deal on the scale of the Concho-RSP merger that allows E&Ps in the same neighborhood to streamline operations and save G&A costs.

“Two plus two equals five is something people are still going to continue to look for,” he said.

Darren Barbee can be reached at dbarbee@hartenergy.com.

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