Unconventional Wisdom

Horizontal drilling and completion technologies have revolutionized the oil and gas industry in recent years. Resource plays, including shale plays (the Barnett, Eagle Ford, or Marcellus, for example) or tight reservoir plays that were originally developed with limited success using vertical drilling (examples include the Bakken, Mississippi Lime and Cleveland Sand) are highly sought-after in the A&D market due to the increased recoverability and decreased risk of horizontal development.

Coupled with the shift to oil/liquids-weighted assets, these trends over the past three years have driven an increase in the number of unconventional transactions and a value premium for liquids-weighted unconventional assets in the market.

Historical transaction trends. The number and total value of unconventional asset transactions has risen steadily since 2009. In 2009, unconventional asset transactions made up 28% of deals by deal count and 29% by value. In 2011, unconventional property transactions increased to 54% of total deals by count and 83% by value.

Thus far in 2012, there have been 39 asset transactions, totaling $18.7 billion in value. Unconventional asset transactions numbered 24, totaling $8.8 billion in value and representing 62% of the year’s total deals and 47% of the deal value. Of these, 16 transactions, or two-thirds, have been oil weighted. These transactions were dominated by assets in the Bakken (five), the Permian (three), and the Eagle Ford and Niobrara (two each).

Year-to-date, there have been 14 conventional asset transactions totaling $2.7 billion. Ten of these, or 71%, have been oil-weighted and comprise 36% of deal count and only 15% of deal value, showing buyers’ preference for unconventional properties. The “diversified” transaction is the $7.2-billion acquisition of El Paso Corp.’s E&P assets by a consortium including Apollo Global Management and Riverstone Holdings. It comprises 38% of the deal value and is a combination of both conventional and unconventional assets.

Unconventional asset premium. In 2011 and 2012 unconventional oil assets have commanded a premium ranging from 20% to 50% compared to conventional assets. For example, in 2011, a conventional oil-weighted producing property with a reserves-to-production ratio of 20 years brought an average value of $15 per barrel of oil equivalent (BOE) for proved reserves and $105,000 per flowing BOE per day, while an unconventional oil-weighted producing property was valued closer to $20/BOE for proved reserves and $140,000/BOE per day of production, a premium of 33% for both metrics.

In 2012, the values increased to approximately $18.50/BOE for proved reserves and $130,000/BOE per day for a conventional producing asset, and $23/BOE of proved reserves and $150,000/BOE per day for an unconventional oil-weighted asset. This represents a 24% premium for the proved reserve metric and a 15% premium for the production or flowing metric. The premium was larger for shorter-life oil-weighted properties than for longer-life assets.

Reasons cited for the premium include the low-risk nature of resource plays once reservoir parameters are better understood , repeatability of results, high initial production rates, multi-stacked reservoir targets in certain areas, attractive ultimate recoveries of reserves and, most importantly, attractive internal rates of return on the drilling opportunities. The premium paid for oil/liquids–weighted unconventional assets is expected to continue as more shale plays and tight reservoir plays are developed.