Ben Dell doesn’t just want to change how oilfield executives are paid. He thinks there could be a lot fewer of them around.
As crude prices rise, companies will be tempted to spend more to boost output, he said, even as investors seek higher returns. The answer: mergers and acquisitions, said Dell, a managing partner at Kimmeridge Energy Management Co., a private-equity firm with about $1.7 billion in limited-partner commitments since its founding in 2012.
Now, many explorers spend needlessly on administration and other overhead even as they work close by in the same shale basins, he said. Dell is among a growing chorus of shale investors pressing for better returns. His remarks on consolidation follow similar comments by others, including Goldman Sachs Group Inc. in November.
“You’re going to see an increasing amount of investors get involved in the space, looking to force companies into combinations,” Dell said in a telephone interview. “The reality is if you weren’t motivated by preserving your job, you would run these companies completely differently.”
West Texas Intermediate, the U.S. benchmark crude, has climbed almost 50 percent since June and now sits above $60. But producers have failed to keep up, growing their share prices by roughly half that amount in the same period. At the same time, oil and gas mergers in the U.S. and Canada fell 12 percent last year to $129 billion, according to data compiled by Bloomberg.
Dell says investors are concerned explorers will return to old habits moving forward.
“When oil prices go up, these guys spend like drunken sailors,” he said. “When oil prices go down, they turn around and say, ‘Look, it’s not my fault the oil price went down. I can’t be expected to manage this commodity.”’
In the Permian Basin, more than 40 companies with at least 20,000 acres each are ripe for consolidation, while in the smaller Niobrara field of Colorado, Dell sees eight drillers that could combine to slash more than $1 billion in the corporate cost identified on balance sheets as “selling, general and administrative,” or SG&A.
Dell’s Kimmeridge owns stakes in PDC Energy Inc., Carrizo Oil & Gas Inc. and Resolute Energy Corp. Dell declined to comment on how his consolidation views related to the companies Kimmeridge owns.
Large explorers outspent their cash flow by 117 percent over the past seven years, according to Barclays. The top 15 oil companies have paid executives $2.8 billion over the past decade while delivering a smaller return to shareholders versus other industries.
Closing the Gap
Corporate consolidation can help close the gap between oil’s rise and lagging driller shares, according to a Goldman Sachs Group Inc. research note at the end of November.
“We believe U.S. shale producers will see a rising need for scale to further improve recovery rates and lower supply costs,” a group of analysts at the firm led by Brian Singer wrote. “This could bring a new term to the investor lexicon: The SuperE&P.”
Explorers bulked up during the shale boom primarily through individual asset deals, Victor Barcot, managing director of energy investment banking at Houlihan Lokey Inc., said in a phone interview. Now that the land grab is essentially over, the opportunity for producers to buy big asset packages in some of the hottest plays is fading, pushing companies to consider corporate deals.
Yet consolidation among explorers won’t be easy, David Deckelbaum, an analyst at KeyBanc Capital Markets Inc. in New York, said in a phone interview. This era of lower oil prices makes it especially hard to pay a premium in a merger.
“You’ll probably see consolidation that’s more in the order of mergers of equals, or stock-for-stock deals,” Deckelbaum said.
Human dynamics can’t be ignored in all this, said Buddy Clark, an oilfield transactions attorney at Haynes & Boone LLP in Houston. He expects companies will try to just keep their own assets, forgoing deals.
“Each management team thinks they have the secret sauce,” Clark said.