[Editor's note: A version of this story appears in the January 2019 edition of Oil and Gas Investor. Subscribe to the magazine here.]

Some public companies’ stock prices are depressed, so issuing more stock is not the solution. And fewer privately held producers are completing IPOs as potential shareholders remain cautious on commodity prices.

For example, Dallas-based Berry Petroleum Corp. (NASDAQ: BRY) that was spun out of Linn Energy Inc. aimed this past summer to raise $367 million from its IPO for itself and for selling shareholders. The deal priced at $14 a share rather than the $15-to-$17 estimate and 13 million shares were sold rather than 21.6 million.

For producers seeking other capital, private-equity investors remain. These three firms seek deals of less than $200 million and tend to focus on less-popular basins that still have a large amount of reserves remaining.

Expertise In Their Regions

Based in Houston and Calgary and formed in 2007, Arcadius Capital Partners Inc. targets smaller, regional operators with lower-risk strategies. “We are focused on the underserved, lower middle market and companies that can deliver outsized returns,” said Tym Tombar, managing director.

“Our firm wants to leverage competitive strengths and build out a portfolio in the upstream business to take advantage of inefficiencies in the micro-cap space.”

Arcadius’ strategy is to partner profitably with seasoned managers to build businesses with strong returns by investing in basins in the U.S. and Canada that are highly fragmented and under-exploited, he said.

The firm has made investments in operators with assets in South Louisiana, the Powder River Basin in Montana and Wyoming, the conventional areas of the Permian Basin and in Central Alberta in Canada.

It invests mainly in conventional “cost-competitive asset positions and, in many cases, have some unconventional upside to them,” Tombar said.

These portfolio companies are led by management teams that demonstrate insight into, and expertise in, their regions. “We partner with the management teams to build out their asset positions, usually with a narrow two- to three-county or -parish focus,” he said.

The assets are well-positioned on the cost curve, Tombar said. “Whether oil is $45 or $75 a barrel, we have to find a way to make money and we look for companies that are always in plays that are most cost-effective.”

By not solely focusing on the shale regions, Arcadius has sought opportunities in basins where oil was discovered and exploited in the 1940s through the 1980s and still have the ability to produce more. “While these assets are not as large as the shale plays, we can deploy incremental capital that is typically $30- to $35 million and seek to triple our investment,” Tombar said.

Compared with those of larger public companies, these assets do not move the needle as much. But working with a team a half-dozen or fewer energy professionals that have insights on the particular basin means Arcadius can sell the asset profitably.

The firm likes the resources in South Louisiana that were discovered in the 1940s. One investment is in Sugar Land, Texas-based Premience Energy LLC, which is focusing on three of 20 producing zones in a South Louisiana oil field.

“These three zones are very prolific and the previous company was unable to commingle a number of zones,” Tombar said. “The management team was able to unitize the field in such a way that they can now commingle zones from 6,500 to 9,700 feet effectively.”

Newer technology has enabled many operators with better methods of produced-water disposal, he added. The position Premience has put together has the potential to produce an additional 10- to 20 million barrels of oil.

“We do take advantage of the advances in technology and are also relying on people who have expertise working in larger, integrated oil companies or large independents and are redeploying their talent and expertise on assets that have been undercapitalized and undermanaged,” Tombar said.

At Arcadius, investments have generally been below $200 million, while the firm’s sweet spot is between $25- and $45 million. “We don’t like the large, single-well event risks that might leave us and the company more exposed,” he said. “We are investing in plays that are cost-effective—i.e., spending less than $700,000 to drill a well in the eastern shelf of the Permian.”

He added that “our end of the market is less competitive. We are looking at opportunities to capture attractive assets with substantial discounts to market metrics, and we tend to have a better profile of assets often with relatively much more low-hanging fruit.”

During the past two to three years, E&P-focused private-equity firms have worked to distinguish themselves to generate outsized returns, he said. When oil dipped to $45 a barrel, the industry was forced to think more critically and find the right basins.

“It’s been painful from an investor-sentiment standpoint, while it has created opportunities for people who are committed to investing for the longer term,” he said.

The firm’s last exits were in 2014—two portfolio companies that were sold in their entirety and two that were sold in parts. These had assets in the Eagle Ford, the Wattenberg Field, Southeast Texas and Central Oklahoma.

Since those sales, the firm has been waiting for the right opportunity. “We might be selling a company [operating] in the Powder River Basin sometime in 2019,” Tombar said.

Applying Tech Advancement

Formed in 2008, New York-based Coral Reef Capital LLC targets smaller E&Ps whose management teams have proven operator records of creating shareholder value for buy-and-build growth strategies in upstream North American energy assets, said Marceau Schlumberger, co-founder and managing partner. Its latest fund, CRC Energy Fund LP, has made two platform investments.

“We focus on acquiring and developing neglected, mismanaged, undercapitalized assets and backing management teams to unlock the embedded value of those assets through operations improvement or by applying recent advances made in drilling and completion,” Schlumberger said.

One area the firm focuses on is regional consolidations in the U.S. and Canada. In a short period of time, its portfolio companies have grown eight to 10 times in size by making add-on acquisitions that provide synergies and growth opportunities.

Management teams leverage their industry experience and knowledge of a basin to manage assets better. Schlumberger added, “Upstream E&P is blocking and tackling, but also a high-tech business.” Data-driven decisions lead to proper risk management and better business outcomes.

“We are fortunate to work every day with industry leaders that can apply their art and science to build companies that now all have more than 10,000 acres of leased land with lots of drilling-growth opportunities and that can grow organically and sustainably with their own generated cash flow,” he said.

“Having well-capitalized, low-leverage balance sheets and low all-in costs of operations of $20 to $30 per barrel allows our companies to take on the risks and make decisions that are necessary to make money.”

The Illinois Basin, which was a leading U.S. producer in the early 20th century, is the focus of portfolio company Shawnee Oil Co. LLC, based in Carmi, Ill. It holds 12,000 acres and 155 producing wells.

“The reservoirs are shallower, and, therefore, costs and risk are lower,” Schlumberger said. “Only a handful of operators in this basin understand slickwater fracking. The innovations that have worked elsewhere in the last 10 years in Texas and Oklahoma are only just starting to be applied successfully across the U.S.”

In Illinois, each well drilled during the past two years is generating two to five times cash-on-cash returns. “The short paybacks on wells allow us to fuel our growth,” he said.

Meanwhile, on the Gulf Coast, secondary recovery techniques, such as dump floods, as well data advances, can be matched with skilled engineering to recover more oil at a low cost. One of Coral Reef’s Gulf Coast-region investments is Mesa Gulf Coast LLC, which is led by a team from Stone Energy Corp. and Chevron Corp. (NYSE: CVX) that pioneered dump floods.

It is applying this high-rate waterflood technique to Valentine Field onshore Lafourche Parish, La., that has historically produced 1 trillion cubic feet of gas and 15 million barrels of oil.

Another investment is Covington, La.-based Krewe Energy LLC, which is also focused on South Louisiana conventional resources. It’s grown production from 500 net equivalent bbl/d to 4,000 in under two years.

Coral Reef typically invests $20- to $40 million in each deal from the CRC Energy Fund. If the firm needs to make a larger investment, it can flex up with its institutional co-investors and limited partners.

“We like to work with people we have gotten to know over a period of time to become custodians of our capital and deploy it,” Schlumberger said. “Not only are we picking management teams, but also the assets to execute with the management teams. They’re running the show and we are the co-pilot.”

The U.S. and Canada are major energy markets endowed with large energy deposits. “More importantly, the real value is the people who are at the cutting edge of significant technological advancements,” he said.

“It is very exciting to work with our management teams to roll out this know-how across basins.”

Overlooked Resources

Founded in 2016, Outfitter Energy Capital LLC invests upstream and midstream. Its principals were founding members and managers of TPH Partners LLC, the legacy private-equity business of energy investment bank Tudor, Pickering, Holt & Co., and Outfitters continues to manage the two predecessor TPH Partners funds.

After multiple monetizations during the past few years, the remaining combined portfolio includes five active companies, including three investments first made in 2013: Elk Meadows Resources LLC, Elm Grove Resources LLC and Principle Petroleum Partners LLC.

Denver-based Elk Meadows exploits resources on the Permian Basin’s Central Basin Platform, primarily targeting the prolific San Andres with horizontal development. Houston-based Elm Grove is currently pursuing horizontal exploitation of the Lower Cotton Valley in East Texas and North Louisiana. Dallas-based Principle Petroleum exploits conventional assets in the Bighorn Basin of Wyoming.

In the Appalachian Basin in 2014, Outfitter joined in forming Pittsburgh-based Laurel Mountain Energy LLC, whose management team has more than 35 years of basin experience and is focused on the Marcellus, Upper Devonian and Utica with some 28,000 acres.

And the firm’s most recent investment, Oklahoma City-based Antioch Energy LLC, holds a roughly 24,000-acre core position in the red-hot Arkoma Basin unconventional-resource Stack play in southeastern Oklahoma.

Outfitter focuses on the lower-middle-market space, typically investing $20- to $100 million per company and with a focus onshore the Lower 48, said George McCormick, co-founder and managing partner. One benefit of smaller deals is that there are simply fewer dollars chasing this space, resulting in less pricing pressure on the initial acquisition.

“We get access to high-quality resources that maybe were overlooked by larger players for no reason other than size,” he said. “While there are more lower-middle-market private-equity managers today than there were when we entered this market 10 years ago, we haven’t felt crowded yet. It’s a big industry that has a big appetite for capital, and we still firmly believe in the opportunity set.”

Portfolio companies grow their assets to an exit size. “By the time we’ve put $50- to $100 million to work in a portfolio company, the resulting asset base is still small enough to take advantage of a very large pool of potential acquirers, including larger privates and private-equity-backed companies as well as public ones,” McCormick said.

“We always start with the end goal in mind, which is to build quality companies that will appeal to a wide audience at exit time. This approach gives us multiple paths to achieve liquidity, which is a real benefit to our strategy, since our job is to drive the best risk-adjusted returns for our [limited partners].”

As a result of current weakness in the A&D market, Outfitter is allocating more money and time to the traditional acquire-and-exploit strategy by buying existing proved reserves “without having to pay for the upside and applying technology and expertise to improve production and reserves to set them up for sale,” he said.

“There are multiple places to play that have these benefits where we can avoid the big-dollar competition and drive attractive returns.”

The firm is currently focused more on liquids—crude oil and NGL—and believes it can make a better bull case from a supply-and-demand perspective for those commodities rather than gas. Also, it likes plays where management teams can apply unconventional technology—horizontal wells, hydraulic fracturing—to proven, oily reservoirs.

“There are lots of opportunities to materially improve the extraction economics in historically produced oil reservoirs,” McCormick said. “We want to be partnered with teams who are best positioned to find and execute on these opportunities, and often that means they are really working in their own backyard.”

One example is the ArkLaTex area, which has a long history of production and is near Henry Hub and LLS pricing. “To be successful, we have to partner with really smart, driven people in the business and help them make money,” he said.

“That’s how we compete. We come to work every day thinking about ways to support our teams, and we demonstrate that dedication with our actions throughout the life of that investment.”

The firm’s role is to help the companies—not simply to provide capital—McCormick said. “This might include making key industry connections or helping to find interesting assets,” he said.

“We spend quite a bit of time on the strategic side, focused on how to position the company’s assets to achieve the best possible exit outcome. We’re trying to help them create value in their company.”

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