Facing a tough commodity environment with fewer organic growth opportunities, private equity sponsors are turning back to acquire-and-exploit strategies, as opposed to lease-and-drill strategies, while also becoming the dominant buyers in data rooms for conventional properties, according to EnCap Investments partner Murphy Markham.

Speaking at Hart Energy’s A&D Strategies and Opportunities conference in Dallas in September, Markham said that, until the recent crash in crude prices, the onset of the “resource play revolution” meant that the lease-and-drill approach accounted for roughly 80% of private equity activity. This was the mirror opposite of 10 years ago, when private equity strategies were focused roughly 80% on acquire-and-exploit, with only 20% employing lease-and-drill strategies.

But with drillbit economics “challenged,” a trend back toward the earlier strategy split was in store.

“I believe the acquire-and-exploit strategies are where the opportunities are going to be, and we’re seeing a lot more opportunities on that front, despite the market being rather quiet because of the low commodity price,” said Markham. More acquire-and-exploit opportunities would likely arise “as companies need to de-lever” in the lower commodity price environment, he noted.

Portfolio companies using lease-and-drill strategies are also adapting to changing market conditions, according to Markham. For example, acreage may be leased in known producing provinces with “limited initial capital exposure.” Only as drilling success warrants, and “as hard value is created,” he suggested, would capital then be “ramped up” for acreage and drilling.

Given the challenge of lower oil prices, however, traditional drillbit economics are more constrained, said Markham, noting that many resource plays do not break even at a $45/bbl West Texas Intermediate (WTI) price. Even in the low-$50s, only a handful of plays—the Stack play and certain portions of the Wolfcamp, Eagle Ford and Niobrara, as well as the better parts of the Marcellus and Utica plays—make money, he said.

With private equity funds collectively having $85 billion to $100 billion to put to work—and EnCap Investments itself having approaching $11 billion available from three of its funds—“the story is one of lots of capital looking for what are few opportunities,” commented Markham. Transactions to date were around $20 billion, he said, with mergers making up around $13 billion of the total.

The more dominant role being played by private equity in oil and gas transactions—at a time when public markets are largely closed or constrained—is reflected in its “drastically” higher participation in data rooms for conventional properties, he said. “Historically, private equity was probably 40% of the people in the data rooms making the bids; today, it’s 85%.”

In addition to “selective acquire-and-exploit” opportunities amid the current low commodity prices, Markham suggested management teams look for what he acknowledged were likely “few and far between” greenfield leasing opportunities in core areas. He termed these the “best value creation opportunities,” involving “low-risk drilling through farm-ins/joint ventures with small and mid-size E&P companies lacking liquidity.”

And people are key. Historically, roughly half of EnCap’s investments are made with management teams that it has previously backed, according to Markham.

“It’s all about people,” he said. “Talent and adaptability of management teams will ultimately drive value.”

Markham observed that while current oil prices were “well below threshold levels” needed to meet the multiyear demand growth, light at the end of the tunnel was far from clear.

“Be prepared to weather low prices for the foreseeable future,” he advised.

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