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

The latest downdraft in oil prices—from $75 per barrel WTI in October to $45 in December—was just another reminder to jilted energy industry investors that, if they didn’t get the message already, “here’s one more reason why you shouldn’t invest in the space,” noted Maynard Holt, CEO of Tudor, Pickering, Holt & Co., speaking at the Houston Energy Finance Group in January. “For four-plus years investors have been trained that these are hard investments.”

Contrast that to the S&P 500 over that period, and, “the rest of the market looked pretty easy to make money in. There’s a lot of frustration in the market.”

But maybe Holt’s subtle message was that now is the darkest before the dawn, which sets up an environment in which both public and private capital can reap big rewards.

On the public front, perceptions and attitudes are key to winning back investors. Investors now believe that management teams are perpetual destroyers of capital, so if any of them are turning an eye at all to upstream investments, it’s solely to companies that are exhibiting certain characteristics, Holt said. These are no surprise to management teams paying attention: spending toward cash-flow neutrality regardless of commodity price outlook; a large, scalable asset base; and a focus on shareholder returns through buybacks, dividends and such.

Scale, too, has come back in vogue, he said. Scale was important to investors in the 1990s when diversity mattered, and a bad word at the onset of the shale era when nimbleness and fast growth mattered most. Now, as shale moves into manufacturing mode, investors want certainty that companies have the ability to manage sizeable portfolios, technology challenges and balance sheets. That translates to scale.

But while investors would rather own bigger companies, the number of oil and gas companies greater than $5 billion in market cap has shrunk. “So the menu is not as attractive right now as it has been,” he said. “Everything points to ‘bigger might be better.’ For almost every reason, suddenly, scale emerges as a positive thing.”

This is playing out in the M&A market, as companies consolidating blossomed in 2018—with more to come, he said. Now is the time for company-building.

“If you’re going to expand your business and get some scale, you’re probably going to have to do it in a public M&A market, because the private assets are not there in the same abundance as they were previously.”

But Holt forewarned that scale in and of itself is not an end-all. “When they consolidate, they need to consolidate under the right management teams. If we get consolidation and the wrong guys take over, we haven’t really accomplished much.”

Corporate culture matters, he emphasized. In addition to capital discipline, investors look also to social and environmental governance. “Culture is defined by what you celebrate and what you punish. Being big does not guarantee anything. Leadership has everything to do with the culture you have as a company.”

But as public companies seek to right themselves with investors, the lack of public capital in the A&D marketplace is setting up opportunities for private capital too, he said. With public investors drying up the capital markets for acquisitions, Holt said he sees companies selling into situations where their PDP value is 150% of their market cap. “This is one of those crazy, oversold, ‘the market has swung too far’ moments,” he said. “If you’re careful and thoughtful, this is where big lessons happen.”

Holt said we’ll look back at this time of waiting for specific deals to happen and say, “Those were 10-baggers”—a 10-times return on investment.

“It is definitely a buyer’s market, but the world is starting to notice that. Money is forming. I wouldn’t say the cavalry is coming, but people see it.”

Will it be private equity? Maybe not, he surmised, comparing private-equity players today to a car dealer with a full lot of cars. “They don’t need any more cars, and if someone tries to sell them a car, it better be a Ferrari. ‘We might take a Ferrari off of you at a discount.’ But the market for Buicks, there are no buyers.”

So the ‘over the fence, into the parking lot’ grand slams won’t be the private-equity deals, he said. Rather, those will come from “longer-dated” money—investors willing to own assets for a very long time.

One potential example: In January, hedge fund Elliott Management Corp. made a public announcement that it wanted to buy QEP Resources Inc. “This is pretty incredible, private capital saying, ‘Let’s take the whole thing.’ The world sees the bargain that is oil and gas after all of this pain, so I think we’re going to get new money in the space this year.”

He also cited Hilcorp’s $2.8 billion acquisition of ConocoPhillips’ San Juan Basin assets in 2017—almost forgotten today—as a precursor example.

“That was huge. If you believe in the fundamentals and you have some cash, and you can hang in there for three, five, seven, nine years, the big money has that in their mentality. I think that’s coming.”

And it won’t be the Ferraris, it will be the Buicks, “those Tier-2 asset bases,” he said.

“If you’re willing to write a check and sit on it, it might be a fantastic return. The downside case is pretty solid, and the upside case is pretty great. The risk profiles are really good. This market is set up for a grand slam, an ‘I can’t believe that happened’ deal. We’re there now.”

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