We are now in a period of unprecedented decoupling of world oil and North American natural gas pricing. The old “normal” used to be ratios of dollars per barrel of oil (WTI pricing) divided by dollars per million British thermal units (MMBtu) of gas (Henry Hub pricing) of between 6:1 and 10:1.

Today’s ratio is more than 40:1. A small component of oil price is due to uncertainty from the Middle East, as Iran makes threats to disrupt Middle East flows. But most of the oil price is driven by fundamental supply and demand. Worldwide demand continues to grow, led by rapidly growing demand from China and India.

At the same time, on the gas side, the industry has discovered huge new volumes of natural gas from shales in North America. This has rapidly driven supply up in what is currently a flat demand environment, putting downward pressure on natural gas prices.

Below are averages for three distinct time periods. The first is from the mid-1990s, in a weak commodity price period, until both oil and gas prices began to strengthen in 2004. The second is during the consistently bullish commodity price period of from 2004 until the collapse in mid-2008. The third shows 2008 through today.

With unrelated factors driving oil prices up and natural gas prices down, U.S. deal flow has quickly pivoted from natural gas dominated in 2008 and 2009 to oil and liquids dominated from 2010 to today. Since 2010, there have been 186 U.S. transactions greater than $100 million with total deal size for these transactions of $153 billion. Of these transactions, 145 have been oil weighted (78%) and $102 billion in value (66%) has been oil weighted.

From a share-price perspective, today it is markedly better as a company to be oil weighted. With the spot oil price up 35% and the spot natural gas price down 51% during this time period, a peer group of oil-weighted companies’ share prices is up an astounding 94%, with gas-weighted companies down 9% during the same time period.

Strategic refocus. Some companies anticipated the change in market for oil vs. gas and strategically pivoted to focus on liquids-rich plays. They chose to do so by a combination of methods, including acquisition or merger, grass-roots acreage leasing in liquids-rich plays, or by participating in joint ventures, either as the “seller” of the joint venture, bringing in a partner to accelerate play development, or as a “buyer” in the joint venture, entering a new area to gain access to liquids-rich plays.

Companies such as Chesapeake Energy Corp., EOG Resources Inc. and SandRidge Energy Inc. have pivoted from gas-weighted strategies in 2008 and 2009 to refocus on acquiring acreage and drilling liquids-rich plays. Others have been following similar strategies since then or will begin to in 2012.

As buyers assess cost and relative risk of acquisition opportunities available in joint-venture transactions, some have chosen deals that have significant production and are more fully developed, such as KNOC’s joint venture with Anadarko Petroleum Corp. in the Eagle Ford shale, and Marathon Oil Co.’s acquisition of Hilcorp Inc.’s and KKR’s business in the Eagle Ford.

Others have chosen opportunities that are less proven but also less expensive on a dollar-per-acre metric, such as Sinopec’s joint venture with Devon Energy Corp. in various U.S. liquids-rich plays, and Repsol’s joint venture with SandRidge in the Mississippian Lime.

Buyers have been an interesting collection of international oil companies, big private-equity firms, and U.S.-based companies. The macro outlook driving these companies to complete deals involves the return potential for U.S. liquids-rich resource plays, among the most attractive in the world, and an expectation of rising worldwide oil demand.

Sellers are driven to complete deals to capture premiums for the current oil-price environment and, in the case of joint-venture operators bringing in partners, to raise capital in a very attractive environment, allowing acceleration of oil resource drilling and production.

—Bill Marko, Jefferies & Co. Inc., wmarko@jefferies.com , 713- 774-2000 For details on assets on the market, see A-Dcenter.com.

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