Why the Haynesville Has an A&D Problem (and the Market is to Blame)

A&D, particularly in the Haynesville, is in a bind.

Partly, that’s the fault of a suddenly giddy natural gas price environment that has blown in gale force headwinds for deal makers.

Despite high gas prices, A&D has been left in the lurch, particularly in the Haynesville where the gas-rich shale will play a central role in the U.S. LNG, provided operators have the inventory they need.

With A&D hampered by a wide bid-ask spread, market factors may instead push companies toward more mergers or deals featuring stock-heavy consideration. And public companies are gravitating toward deals as they look to build runway—with the added danger of being hard-pressed to pay strip value for what they need.

The headwinds are fierce. Gas-weighted public company shares trade far below multiples based on natural gas prices. Sellers, meantime, are unwilling to part with their assets without getting fair value based on current strip prices.

That’s put a crimp in dealmaking, with A&D stalling and mergers the more likely way to placate sellers.

The chief villain in the deal market is price dislocation. In the present, prices are up. But years into the future, their value collapses—a phenomenon known as backwardation. As of June 6, natural gas contracts for 2022 were $9.23 per Mcf of natural gas, according to KeyBank National Association. That compares to 2025 contracts that value an Mcf of gas at just $4.58.

The backwardation persists despite recent acknowledgments by policymakers that the economy will rely on natural gas for electrical generation, chemical use and refining diesel.

Even with the rebound in asset-level transactions in 2020 and 2021, transaction levels won’t satisfy the long-term inventory needs Haynesville operators to acquire as they try to keep pace with demand. That demand includes a freshly made commitment to supply Europe with an additional 4.8 Bcf/d of LNG by 2030.

Grant Butkus, a managing director at RBC Richardson Barr where he leads corporate and asset transactions, said the plateau in A&D transactions may leave companies no choice but to use mergers and stock inducements to get deals done. 

Speaking on May 26 at Hart Energy’s DUG Haynesville Conference and Exhibition in Shreveport, La., Butkus noted that natural gas deal activity and increased investor interest was energized before the Russian invasion of Ukraine brought natural gas into the fore of discussions.

“This is something that’s much more structural that’s been building over time,” he said. “It’s really been building over the last couple of years as people start to understand that gas is a much more fundamental part of the overall energy ecosystem and it’s going to be that way for a very long period of time.

Recent International Energy Agency (IEA) reports note that the world will still consume a majority of natural gas in 2050, even in zero-carbon or net-zero scenarios.

Both 2021 and 2022 were characterized by outsized energy sector returns, strong commodity prices, and a highly active A&D market. Yet natural gas-weighted public companies trail their oily peers.

Large-cap oil companies trade at a 27% discount to WTI prices, according to RBC. Small- and mid-cap companies are at a 37% discount. And natural gas-weighted companies trade at a whopping 55% discount to Henry Hub prices, Butkus said.

And that creates a disconnect between public buyers and private sellers.

“The readthrough on that is most public companies don’t get credit for where strip is today,” he said. “So, if you’re a public company and you go try to buy private assets, the private asset owners, private equity owners, private companies want their assets valued at strip. But you would effectively be valuing their assets above where your assets sit today.”

Public companies face a dilemma of buying assets for cash at a cost that exceeds their own inventory.

Instead, public companies will be pushed into making acquisitions by creating relative valuations with their stock.

“So that’s either issuing a large amount of stock to private sellers so you’re able to acquire at your stock valuation and then as you appreciate the sellers also share in that upside,” Butkus said. “Or you’re looking at a public company to public company M&A.”

But there are some signs that the call on natural gas has caused some investors to wake up to its potential.

“There’s going to be a lot of interest from buyers out there,” he said. “We’re seeing that out there in the processes we’re running today.”

Butkus said he’s seen a sizeable amount of new investor interest both from the public equity and private equity markets looking to get into natural gas.

“But to offset that,” he added, “we’re also seeing an incredibly volatile commodity price which makes it difficult for deals to get ultimately done without trying to find ways that both sides of that transaction can share in the upside as the markets equalize and as we continue to see the back end of the curve start to catch up with where we sit today.”

M&A drivers

In the past few years, Butkus said some M&A deals were “defensive in nature” to shore up balance sheets. But the majority of M&A transactions have been focused on inventory.

“We are seeing Appalachian producers moving into the Haynesville,” he said, “acquiring companies that have inventory that they can develop that they can accelerate because they’re constrained on their primary assets.”

But RBC reckons that further transactions need to be made. On paper, RBC analysis of seven Haynesville public companies shows a collective “advertised” inventory of 109 years. But digging deeper, RBC sees core inventory among the Haynesville at about 50 years, with some companies holding just four more years of runway at their current drilling pace.

“Every operator is drilling their best inventory today,” Butkus said. “The issue you run into is if you’re drilling your best inventory, it’s your most capital efficient, you can replace your decline with the lowest capex budget, it generates your highest free cash flow.”

But the Tier 2 inventory means E&P capital efficiency will fall.

“What we really see is that companies that are really focused on those core metrics are going to continue to drill core inventory,” Butkus said. “And this is what’s really driving acquisitions within the gas basins and M&A, continuing to replenish not just total inventory but core high-quality inventory.”

Replacing inventory from the A&D market has been sporadic, with lower participation because fewer private companies own high-quality inventory, he said.

“The opportunity to go out and buy small private companies and get core gas inventory has been significantly reduced from where it was before,” Butkus said. “So that’s really is pointing M&A toward having to buy other companies if you’re a public that that needs to increase your inventory.”

“So, that’s one of the key headwinds and one of the key drivers we see for gas M&A,” he said.

Why Haynesville?

The Haynesville is perhaps the most logical area for LNG exports, including those needed by Europe, to originate. New liquefication capacity is coming online in the Gulf Coast but other basins may find it difficult to participate.

Butkus noted that the Permian Basin’s natural gas is a secondary produce production that is already moving gas to Mexico. The Rockies may lack the development room to produce more gas. The Midcontinent producers face constrained takeaway and Appalachia “is completely tapped on takeaway.”

“We’ve seen almost every pipe that tries to get built out of Appalachia run into political roadblocks left and right,” he said. “Unless we see a big push for infrastructure for Appalachia, really the call for LNG and to produce that 4.8 Bcf is going to be on the Haynesville, it’s going to be on the Gulf Coast.”

And Butkus believes that will lead investors and companies to push for M&A “as they try to capture inventory and build up a runway of development over the next 5, 10, 15 years.”