HOUSTON—Some oil and gas people enjoy risk, CEO Steve Chazen says, and others fool themselves.

Chazen, CEO of blank-check company TPG Pace Energy Holdings Corp. (NYSE: TPGE), isn’t eager to embrace either possibility.

A few days after going public with a $2.66 billion deal to combine Chazen’s blank-check company with EnerVest Ltd.’s South Texas assets, Chazen explained in an interview with Hart Energy his reasoning behind the assets he chose after nearly a year spent searching for an acquisition.

He considered the Southern Midland Basin, the Stack play in Oklahoma and the Haynesville Shale, despite his grim view of natural gas prices. “It doesn’t strike me as a way to get rich,” he said.

EnerVest’s assets in the Eagle Ford, Austin Chalk and Giddings Field gave him the validation to go ahead with a deal.

“I won't go somewhere where I have doubt about whether the oil is there,” he said. “I'll put up with lots of other risks but if I can't say with 100% certainty that the oil is in place, I'm really not interested.”

TPG and EnerVest agreed in late March to form Magnolia Oil & Gas Corp., with Chazen serving as CEO for the first time since leaving Occidental Petroleum Corp. (NYSE: OXY) in 2016.

Magnolia, which will trade on the New York Stock Exchange, will be carved out EnerVest’s 359,000 net acres in South Texas. One of the most important pieces is 14,070 net acres in Karnes County, Texas.

Current net production is about 40,000 barrels of oil equivalent per day (boe/d), with 31,000 boe/d in Karnes and 9,000 boe/d in Giddings. Production from the combined asset base is 62% oil and, overall, 78% liquids.

Chazen likened the Karnes acreage to “cake” and the Giddings as an opportunity—“the icing.”

“The true value is in the cake, not the icing,” Chazen said. “Maybe we'll get thick icing [in Giddings] but the true value is in Karnes.”

Chazen said he’s not paying much for the Giddings and that PDPs are at least two-thirds of the deal’s value.

“If we got it wrong, we’ll still make a small return,” he said.

Firewall

Magnolia’s economics are based on good times but fortified against the bad.

The company models its economics on West Texas Intermediate prices of $58 and $2.75 Henry Hub pricing. Chazen said he expects oil to average $55 per barrel, give or take $5. But his breakeven economics are roughly $30.

“The point of all of this is you've got to be able to survive the bad times,” he said. “So you build an asset base that survives the bad times. I can execute this program even at $40 oil.”

Magnolia is projecting base 2018 EBITDA of $461 million, with free cash flows of about $240 million on the back of a 2.7 net rig drilling program. An additional acquisition closed by EnerVest on Feb. 1 will raise EBITDA to $513 million, the company said.

The company will also work to buy back stock and grow by about 15%.

“You've got to run these things so any fool can manage them,” Chazen said, “because eventually, one will.”

Karnes offers highly economic wells with payback periods of about six months, based on its oil production, he said.

That compares to the Permian’s 19-month grind to returns. Magnolia’s Eagle Ford wells produce 216,000 barrels of oil (bbl) and Austin Chalk wells 330,000 bbl in their first 12 months, the company said.

Karnes County Austin Chalk wells have also outperformed even the best Eagle Ford and Permian Wolfcamp wells.

The Blueprint

In May 2017, Chazen’s raised $650 million through an IPO and an investment by TPG Pace Group. Magnolia more recently attracted another $350 million in capital after a handful of calls Chazen made to investors he’s worked with for years.

Chazen made headway by going directly to investors. He wasted no time on the intricacies of frack techniques, benches or the best diameters of proppant sand.

The idea was to pitch a story that would appeal to the same investors buying Johnson & Johnson stock.

“I have this business model, right? And this business model generates better multiples, and that's the mathematical pitch to the [investor],” he said.

Chazen’s blueprint relied on capital discipline, free cash flow and growth—a format now in vogue with E&Ps.

After the IPO, Chazen was approached by longtime friend John B. Walker, EnerVest’s CEO and founder, about the South Texas assets last year.

“That's how it came about,” Chazen said. “He didn't really want to know what he wanted to do exactly. He knew I had $650 million dollars.”

Magnolia and EnerVest will operate the assets together. TPG’s deal to acquire EnerVest’s assets includes cash and stock, allowing EnerVest owners to retain a significant ownership stake in Magnolia. Chazen will lead Magnolia as the company’s full-time chairman, president and CEO.

What Fools You

For all of his practicalities, the Giddings appealed to Chazen because of its potential and relatively low cost, he said.

To make money, E&Ps need to buy acreage that offers options that can be unlocked.

That was true about 15 years ago when E&Ps knew about the oil trapped in the Permian Basin but “didn’t know how to get it out of the ground,” he said.

Chazen has high hopes for the Giddings Field, tempered by reserved expectations.

“Whether it turns into a big deal or a medium-sized deal or a small deal, I don't know,” he said. “But I didn't pay much for that option.”

Giddings’ volumes include about 30% oil and are largely produced from conventional Buda gas wells. More recent well tests by EnerVest and GeoSouthern offer a more promising median oil cut of about 59%, with the best well producing 71% oil.

Chazen plans to be thoughtful about drilling the Giddings. Karnes’ rich oil wells allow him the luxury to take his time and zero in on the best locations to drill rather than “waste money” with unsuccessful tests.

Capex in the Giddings Field will be limited to the cash flow it produces. “We’re not taking any money out of the Karnes area and putting it in here,” he said.

Giddings, Chazen reminded, is the icing.

The icing tastes best, a reporter noted.

Chazen shot back: “Or it fools you quicker.”

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

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