A Time To Buy

During the commodity price freefall of 2015, EnerVest Ltd. closed its biggest institutional investor fund to date, Fund XIV, with $2.4 billion of equity. The Hous­ton-based E&P promptly put half of that capi­tal to work. In May, in the heart of the volatile oil window in the Eagle Ford Shale, EnerVest announced it had acquired assets in three deals totaling $1.3 billion.

“It’s a great area,” said EnerVest CEO John Walker. “Our philosophy is to be one of the big­gest drillers and producers in a basin. We’ve done that in Ohio, in the Austin Chalk, the Bar­nett and the Midcontinent, and we’re trying to do it again in the Eagle Ford now.”

The sudden 14,000 net acre Eagle Ford foot­print was acquired from GulfTex Energy, Black­Brush Oil and Gas LP and Alta Mesa Holdings LP. Combined, the position is concentrated in Karnes County, Texas, and comes with produc­tion of nearly 16,000 barrels of oil equivalent per day and 875 upside drilling locations.

In November, EnerVest also invested $875 million in Range Resources Corp.’s legacy coalbed methane Nora Field in southwestern Virginia through Fund XIV.

The company is consistent in moving prop­erties into and out of its portfolio. In 2015, EnerVest transacted on $1.25 billion in both purchases and sales, and year-to-date has al­ready matched that in 2016. With a five-year annual average of nearly $2 billion, EnerVest by itself has represented some 5% to 7% of the entire U.S. A&D marketplace, even through the downturn.

Walker has led EnerVest since its inception in 1992, formed in partnership with Albany, Texas, oilman Jon Rex Jones to purchase and manage oil and gas properties for insti­tutional investors. Walker began his career as an energy analyst on Wall Street before transitioning to buying and managing assets through his own Walker Energy, followed by Torch Energy Advisors.

Today, EnerVest holds 6.5 million acres and more than 33,000 operated and 8,000 non­operated wells across 15 states in its portfo­lio, making it the nation’s largest independent producer by well count. It has some $7 billion in assets under management. It is also par­ent to EV Energy Partners LP, an E&P master limited partnership.

Walker sat down with Oil and Gas Investor recently to discuss the company’s A&D strategy and challenges in the current environment.

Investor Why have you honed in on the Eagle Ford?

Walker The market believes the Permian is the best rock; I think this is the best rock. It’s much cheaper to drill, and we’re get­ting higher EURs. We’re getting LLS pric­ing, not WTI, so we’re getting a premium oil price. When you can drill and complete wells cheaper and are getting higher EURs and a higher price, how could you argue that?

Investor It’s been argued there’s not as much stacked pay here.

Walker We’ve got three zones: Upper and Lower Eagle Ford and the Austin Chalk. In fact, GulfTex has one tract where they’ve drilled a winerack pattern into the Lower Eagle Ford and the Chalk, and they’re all good wells. We’ve spent a lot of money buy­ing seismic, so we’ve got to do it right.

The GulfTex acreage is right on the Karnes Trough in Karnes County—great wells, some of the best wells in the Lower Eagle Ford and some of the best Chalk wells in the play. The Chalk wells are IP’ing at over 3,000 barrels a day. I tell you, there’s no place in the Permian even coming close to that.

Investor Is the Austin Chalk as good beyond the Karnes Trough?

Walker The Chalk comes and goes. There are two great counties in the Eagle Ford play: Karnes and DeWitt. We’re in Karnes and have great Lower Eagle Ford. Nobody really knows about the Upper Eagle Ford yet—there have been some wells drilled, but they’re not as good as the Lower. The difference here versus DeWitt is the best wells are the Austin Chalk wells.

Investor What commodity price do you need to make Eagle Ford wells economic?

Walker They’re economic right now. The question is, when you have 875 locations combined, do you really want to sell flush production at forty-something dollars per bar­rel? By the time we’ve got a rig or a comple­tions unit out there, we hopefully are in the $50s at least. We’ll be bringing on a rig soon.

Investor Did the purchases come with drilled but uncompleted wells (DUCs)?

Walker We have 18 DUCs on BlackBrush. Part of our deal was they would spend all of their drilling capital before the effective date. That lowers our cost. Think about the rate of return on those. The well costs are half, about $2.5 million, with Lower Eagle Ford wells that come on at 1,700 to 2,000 barrels per day. If you look at drilling and completing costs, these wells pay out in a year or less at today’s prices.

Investor Are you still looking in the Eagle Ford?

Walker Yes. We’re working on two other deals right now. That’s what we try to do every place we go. We build these big concen­trations so we can be cost efficient when we put a lot of rigs to work.

Investor What attracted you to Nora Field?

Walker We love Nora Field. It’s a giant pile of gas at 4 Tcf [estimated recoverable re­serves]. We’ve tried to buy it three times in six years.

It’s 360,000 mostly contiguous acres, with 220,000 of those in which we have 100% of the royalty and 100% of the working interest. When you have both the royalty and 100% of the NRI, margins are great.

It’s the only place I know of in the U.S. where we’re getting a gas premium to Henry Hub of 45 to 65 cents per Mcf. A pipe­line runs through our field, over the moun­tains and into southern Virginia, and so far the Marcellus and Utica haven’t found it to upset the price. That alone makes this whole thing attractive.

And then there is no seismic with more than 4,000 wells drilled. Most are coal­bed methane and conventional, with fewer than 20 Huron Shale wells drilled. With no seismic and no well drilled deeper than 6,000 feet, you’ve just got too much gas for the Huron Shale to be the only source rock. So somewhere be­tween 6,000 and 13,000 feet, you’ve proba­bly got something else that’s a source rock. We’re going to shoot seismic and drill some wells.

Investor Do economics work on what you bought?

Walker Absolutely. It’s our only rig that we’ve got running right now, and results are exceeding our expectations. We’ve drilled 12 wells into the coalbed, all vertical wells, and even with the lower gas prices, we’re getting in excess of 20% ROR.

Investor Is the time right for making acqui­sitions?

Walker I think it’s a wonderful buying oppor­tunity. I wish we had spent our whole Fund at Nora, in the Permian and the Eagle Ford. We’ve spent just 51% of our fund.

Investor But you haven’t made a Permian ac­quisition recently.

Walker We’ve bid on some things in the Permian, but we haven’t been able to buy those. We’re getting beat by 50% to 100%. That’s primarily Midland Basin, but we’ve bid on some Delaware Basin stuff, too.

You have the public market supporting these companies that are bidding these big prices, and for them it probably makes sense. They’re already present there, it’s adding to their posi­tions and they’re cost efficient. They have a bidding advantage over us, and they’re pay­ing some pretty good prices.

Investor What are your buying criteria?

Walker Our buying criteria is primarily good rock, but it’s far more complex than that. We look at every single well and at all categories: the PDP, the behind pipe, the PUDs, the probables and possibles. If you buy big, contiguous positions with the best rock possible, then you have something at­tractive to develop.

Investor Are you targeting any distressed assets?

Walker It doesn’t fit our philosophy. A lot of companies in bad financial shape don’t have very good assets. You can prob­ably make good deals, but what do you re­ally have?

Investor Do you prefer oil or gas?

Walker We prefer oil and liquids to gas; it’s just so hard to buy oil. I just think there’s more upside to oil and liquids right now.

After we sold our Permian and Bakken positions in 2014, we were 70% gas and 10% oil, but we’ve spent $1.3 billion this year on properties that are 90% oil and liq­uids. I’m optimistic on liquids. Liquids prices have actually outpaced oil in recov­ery. Ethane and propane have really been clobbered.

Investor What’s your outlook for oil?

Walker Very positive from the standpoint that, based upon fundamentals, we probably should be at $60 by year-end and continuing to increase.

My one qualifier is the lack of liquidity in the commodities markets. Everybody on the way down said this would stop at $70 or $65 because of economics, and no one thought it would be $26/bbl. But with that lack of li­quidity, when the pendulum starts swinging, it always swings further than you think.

I think it will swing higher on the way up; I just don’t know where it will go.

Investor What is your outlook for gas?

Walker We’re going to have a heck of a lot of gas going into the winter. If we keep hav­ing these warm winters, you can’t have a good outlook for gas. You just can’t. These nonexistent winters have killed us. We’re very dependent on having a normal to colder than normal winter.

Investor Will other demand drivers have any effect?

Walker There is a chance you could have demand outpace supply between now and 2022 with LNG exports, exports to Mexico and fuel burn for power. Also, there is $150- to $160 billion being spent on petrochem in Texas and Louisiana that will burn gas to fuel it, about 4 Bcf/d.

Investor But you’re not investing in gas today based on that?

Walker We did invest in gas, but in gas that has a premium price. When you have an op­portunity to buy one of the best gas fields with those kinds of margins, you take it. Nora is the second highest margin in En­erVest’s portfolio.

I can’t tell you how many gas deals we don’t evaluate because we don’t think they’re in the right place. We could buy a lot of gas deals.

Investor In previous funds, you’ve been a contrarian on buying gas when everyone else was running to oil. Did those investments work out like you anticipated?

Walker No, they haven’t. The price of gas in 2014 was over $4/Mcf, and our major mistake was not selling everything we had. I didn’t anticipate 2015/16 being the warmest winter in recorded history. In April, we had an extra 1 Tcf of gas we shouldn’t have had if it was a normal winter.

Investor Did you hedge those acquisitions?

Walker Remember, the oil and gas markets were back­wardated 2012 through 2014, over three years in a row of backwardation, and I ignored that.

I typically disregard the fu­tures market, because it’s right only about 10% of the time. This time it was right, and I was wrong, and we were only hedging out one year.

As soon as we could we started adding on hedges, but we didn’t have any major hedges out there on gas in par­ticular. We’ve had to add a lot, but it was well below our ac­quisition economics.

Investor What about the Western Anadarko Basin? You have built a position there while others were retreating.

Walker We like the West­ern Anadarko, but the same thing has happened there that has happened to every other place. We had a lot of rigs op­erating and were drilling good wells, then bam, they just don’t make economic sense right now. You don’t get the same consistency that you get in the Eagle Ford or the Wolfcamp B.

Investor Are you as sold on it as you were when you made your acquisitions?

Walker Because there are a lot of oil and liquids, if we have a recovery, I think we’ll do OK. But rates of return are killed any time you lose two years. If you are dependent upon delivering a rate of return, and you can’t get a rate of return over a two year period, it’s almost impossible to catch up.

Our minimum rate of return to spend any capital is 20% risk adjusted. We just can’t justify that in the Midcon now.

Investor What price would you need to have a rig running there?

Walker Probably $70 to $75/bbl. I think we’ll get there in 2017.

Investor Have you cracked the code on the Utica oil window?

Walker No. At a much higher price we can do some more experimenta­tion. We’ve drilled a $20 million well there with seven other pretty big com­panies joining us. We were afraid the frack water was damaging permeabil­ity, but water wasn’t the issue. We don’t have the solution yet. I’m not saying we won’t; probably in some parts further east we will.

However, we’ve got tremendous acre­age in the wet gas window. That’s really good acreage.

Investor What about the Clinton sand­stone? You were testing some concept there.

Walker We made good progress in that, but we shut it down because these are not giant oil wells. We need at least $70 oil for that to work, then we could hit our 20% rate of return.

Investor What do you plan to do with your Barnett assets? Any potential for refracks?

Walker We probably won’t refrack, but we’ve got seismic over most of it, and we’d like to continue to consolidate there. We’ll sell some things, then buy others. We bid on a package recently in the Barnett, but we didn’t win it.

Investor What kinds of returns have your latest funds delivered?

Walker Funds I through IX averaged 35% rate of return all in. Fund X is sin­gle digits, and Fund XI has about a 15% rate of return.

Funds XII and XIII, I don’t know if they will deliver any return. And Fund XIV will be extremely high.

Investor Why do you think Fund XIV will be so high?

Walker We’ve bought in the best rock in the country. If you’re buying at $40 and selling at $80 to $100 per barrel, we’re going to be drilling a lot of wells that pay out in less than a year. I think we can prove up quite a bit of it and turn around and sell it.

Investor Of the two funds that are under water, would you or could you have done anything differently?

Walker In hindsight, we could have done an enormous number of things differently.

We probably would not have acquired so rapidly in the Midcon.

We would have hedged out longer. The biggest issue was we should have had three to five years of hedges in place—a major mistake on my part. You need to be hedged out for a minimum of three years, in frothy markets particularly, even if it’s backwardated.

We wouldn’t have had as much debt as we did—and we thought we didn’t have that much debt. We were probably 30% levered. Anything over 25% debt-to-capitalization is too high.

Investor You’ve just gone through a period of fundraising. What’s the sentiment of investors?

Walker We raised $2.4 billion—it’s the big­gest fund we’ve ever raised. I tried to be em­phatic that it’s a great time to be putting money to work.

Investor Is there a flood of investment money looking for placement?

Walker I don’t know. It would be interesting going out now.

A lot of people have invested in this industry and gotten great returns in the last 20 years, but a lot of those same inves­tors have total write-offs this time. Some funds have not gotten hardly any of their money back. I think EnerVest and some of the other sponsors will still be able to raise money, but some are going to go out of business.

Investor What was your message to the lim­ited partners as you were fundraising?

Walker Our message was, if you look at our history, the best returns we’ve delivered are coming out of these downturns. Some be­lieved us, and some decided to wait and see.

Investor Have expectations of investors changed?

Walker They are more cautious. Some will want to watch this for a while, which is the opposite of what they should be doing. They should recognize that these are the times when you need to be investing. You shouldn’t wait for $100 oil to come back be­fore you start investing again. After all, the best time to buy straw hats is in December.

Investor Is the E&P MLP model viable or sustainable in a volatile price environment?

Walker I think it is viable from the stand­point that it is a very good yield vehicle.

Secondly, about 81% of the oil wells in the U.S. and 70% of gas wells are stripper wells, so there are a whole bunch of ideal assets out there that aren’t well suited to a C-corp. If people want to own investments that don’t have stock market variability, they can own the asset directly as long as these entities hedge wisely and protect their yield.

Investor How has EVEP fared during the downturn?

Walker We’re the only clear survivor right now. We have a good balance sheet and good liquidity; that’s based on our earnings, not hedges that run out in a year or two. We acted very early and sold $735 million of midstream assets to pay down our bank debt, and now we have the lowest debt of any of the other MLPs.

At one point we had our debt down to zero, and we thought we could spend $200 million to show some growth. In 2016, the banks approved us to spend $35 million in liquidity, either to buy back bonds or on dis­tributions. Our bonds were trading from 25 to 40 [cents on the dollar], so we halted our distributions and bought back about $80 million worth of bonds this year with that $35 million.

Unfortunately, we’re being treated like the bankrupt MLPs by Wall Street. We’re a clear survivor here.

Investor What mistakes has the broader group of E&P MLPs made?

Walker It’s all about leverage. Beware of leverage. That’s what’s taking down a lot of these companies.

Investor What role has EnerVest played in addressing the new banking restrictions im­posed by the Office of the Comptroller of the Currency?

Walker We have spoken with our represen­tatives in the U.S. House and Senate to share examples of the unintended consequences of the changes that were made. I know that at least one other company has provided ex­amples of the impact as well. I have a cer­tain level of comfort that we can address the issue collectively and find common ground that meets the needs of the OCC, the banks and the oil and gas industry.

Investor What was the message you sent?

Walker The message was that their peo­ple in the four major banks—Wells Fargo, J.P. Morgan, Bank of America, and Citi­bank—were not very well trained, and they had final credit say. Some were doing very arbitrary things that were not within the guidelines.

Secondly, some of the guidelines were too severe. The changes that were being made to the guidelines were written by people that didn’t understand reserve-based lending, and wouldn’t listen to the banks.

Investor Were you effective in that?

Walker I think so. I’ll know this summer. The comptroller has agreed to talk to the in­dustry this summer, and to rein in those peo­ple in the banks.

Investor What would be the risk to the in­dustry if you didn’t get that changed?

Walker As the guidelines are stated now, there’s going to be a lot less capital available from the banks in the future, and it’s going to cost a lot more.

Investor Do you find this downturn differ­ent than others you’ve experienced?

Walker It’s the deepest and most difficult. It came down faster and further than at any other time.

Investor What lessons should the industry take away from this downturn?

Walker We shouldn’t rationalize anything. Everybody should look at their own deci­sions and actions and ask, ‘What should I have done and, when the next rebound oc­curs, how am I going to act?’ If people rationalize that they didn’t do anything wrong, and it was the downturn that got them, they’re destined to fail.