Those familiar with “It’s a Wonderful Life,” the classic Christmas film star- ring Jimmy Stewart, may remember the scene in which George Bailey—despairing and about to throw himself off a bridge— is shown by his guardian angel, Clarence, how different the lives of those in Bedford Falls would have been if George had never existed. It’s both uplifting and a tearjerker.

In energy, can we imagine what our lives might be like without the revolution we have experienced in horizontal drilling and hydraulic fracturing?

Gasoline might cost close to $5 per gallon, as U.S. oil imports would likely reach 10.5 million barrels per day at a cost of $140 per barrel, or $127 billion per year. Utility bills would be steeper by two to three times, as 14- to 16 billion cubic feet per day of natural gas would be imported at $12 per thousand cubic feet (Mcf), costing $70 billion per year. These estimates are according to IHS research director and advisor in energy Steve Trammel, speaking at a recent Denver forum hosted by Davis Graham & Stubbs LLP.

The average household could suffer a $1,200 drop in annual household income. A U.S. manufacturing renaissance sparked by low energy costs would not be underway, and 2.1 million extra American jobs would not have materialized, contributing to an un- employment rate approaching 8%. The U.S. might be in an extended period of low or no economic growth, with $3.3 trillion lost in

U.S. gross domestic product from 2010 to 2020—all opportunity costs in the absence of the U.S. energy revolution.

Plenty gloomy, to be sure … but enough of what might have been. The U.S. energy sector is leading the world in oil production growth, and the drive toward “hydrocarbon manufacturing” continues to make strides. What might lie ahead?

One topic of discussion at the forum was the yawning valuation disparity between producing reserves, which often find a market among upstream master limited partnerships (MLPs), and reserves that are classified as proved undeveloped (PUDs), for which traditional E&P buyers are largely absent.

Transactions for the former reflect present values calculated using a third-party reserve report and, in the current interest rate environment, record low discount rates of 6% to 8%. These often amenable valuations contrast sharply with valuation metrics applied to PUDs, where discount rates are commonly as high as 25% to 30%—and which are typically applied after also having “risked” or haircut the proved reserve estimates by 10% to 25%.

How to bridge the valuation gap? In an era of multiwell pad development, or “batch drilling,” would it not also make sense to add a step after the manufacturing process to conduct periodic batch sales of fully developed pads? This could keep the manufacturing process running both in terms of rising production and in E&Ps’ ability to recoup their capital on an accelerated basis.

The idea here is to develop a symbiotic relationship between an E&P and MLP, allowing each side to anticipate successive transactions involving fully developed properties based on third-party reserve reports, the 12-month commodity futures strip and, as an example, a 7% discount rate. Inevitably, there will be variations in wells’ estimated ultimate recoveries, but there would be no cherry picking allowed under an agreed structure incorporating these three key elements.

But aren’t MLPs more focused on buying mature properties where decline curves have flattened?

Yes, pad drilling would normally imply initial sharper decline curves, but there is precedent for structuring deals to help offset production declines. One example involved selling an initial lower working interest in a property that would then grow by an increment each month, subject to an upper limit, allowing the buyer to own a rising working interest in a declining production stream.

In addition to being able to monetize drilling and completion dollars in a timely fashion—and at a more palatable price at a time when the less liquid market for PUD properties offers a poor alternative—E&Ps would benefit from a technical perspective. Full development via pad drilling offers E&Ps advantages in greater fracing efficiency, transportation costs, water management and more.

Ultimately, the concept optimizes the distinct competencies of each of the respective parties. For an E&P, its core competency lies in the technical sphere of drilling and completion; for an MLP, it lies more in its access to lower-cost capital.

Maybe one day we’ll also wonder: What if this, too, hadn’t existed?

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