American Oil and Gas Reporter - May 2016 - 40

Capital Strategy Key To A&D Success
By Mike Turner

without the capital to develop it is simply
putting a three-year hold on the drilling
rights.
With low commodity prices forcing
oil and gas companies to cut capex and
reduce drilling activity, leases that cannot
be held by production must be re-leased
at an increased cost to the leaseholder.
This creates an opportunity to flip the
acreage to other producers that may have
more capital available to support drilling
those leases so they don't have to be reacquired.
In other cases, producers are working
to be more efficient in their spending by
focusing on a smaller number of resource
plays or a smaller position within a single
play. In effect, this move to efficiency

HOUSTON-Increased acquisition and
divestiture activity is expected during the
second half of 2016, following bank borrowing-base redeterminations this spring
in anticipation of market and product
pricing improvements over the next few
quarters.
Companies that were long on commodities before the price collapse will
need to sell assets to shore up their
balance sheets and reduce their leverage.
Interested buying parties will be companies with equity that are seeking upside
potential in properties with proved developed nonproducing and proved undeveloped reserves, along with price ap-

FINANCING THE DEAL
Operators should be ready to
demonstrate their ability to operate
efficiently in the current environment,
and have ample liquidity and equity
support with a robust risk management program.

Mike Turner
President
Mutual of Omaha Bank,
Houston
preciation from the acquired production.
From what we are seeing so far, proved
developed producing reserves alone will
not be sufficient from the buyer's perspective.
Lenders generally are agnostic about
whether an asset is conventional or unconventional, but since unconventional
plays are more expensive to develop,
companies should be aware that these
properties are harder to finance. Only
those plays with multiple stacked pays
seem to make sense.
The key to success in resource plays
remains acquiring the right acreage at
the right price at the right time. When
acreage is acquired, the ability of the
purchaser to fund capital expenditures
should be considered, so that drilling can
be undertaken to bring on production to
hold leases. After all, acquiring acreage
40 THE AMERICAN OIL & GAS REPORTER

has created opportunities for property acquisitions by other parties looking to expand their acreage positions or enter plays
in which few reasonable acreage opportunities existed in the past.
PDP-Based Purchase Prices
Producers are trying to acquire properties for a purchase price based on PDP
assets, expecting PUD and PDNP assets
to come with the producing properties at
no real cost. That allows the PDP purchase
to be financed by conventional means
while the nonproducing assets sweeten
the deal for both the purchaser and lender.
This is the most viable way for nonproducing assets to be included in financing.
The ability to finance acreage-only
positions was always difficult, but it is
nearly impossible now, since no cash

flow comes with buying acreage, but
buying acreage comes with a large capex
requirement to make it sustainable.
The way banks underwrite does not
change, whether one is in a $100 or $30
oil price environment. The bank still has
to collateralize reserves or other midstream
assets for credit facilities, and the borrower
still has to demonstrate it is able to operate
profitably in the prevailing market. It is
the transition period that is difficult to
navigate as the asset bases of companies
that were capitalized based on higher
commodity price points are impaired,
leaving them overleveraged.
During the bull market, many banks
were providing capital to the upstream
and midstream sectors with borrowerfriendly terms. Going forward, oil and
gas companies can expect to see more
traditional terms and conditions. Mutual
of Omaha Bank has completed several
transactions this year, ranging from recapitalizations of existing clients to onboarding new relationships, and will continue to seek new opportunities with credit-quality upstream and midstream firms.
Operators should be ready to demonstrate their ability to operate efficiently
in the current environment, and have
ample liquidity and equity support with
a robust risk management program. Of
particular importance are the ability to
explain drilling and development costs,
and hopefully, to align with an equity
partner. Companies should be open and
upfront with potential lenders, and be
willing to proactively run a targeted
asset's engineering past lenders to help
determine the amount of debt and the
terms each lender will be willing to provide.
The main risk factors in a potential
property acquisition are diminished cash
flows and reduced asset valuations, as
well as future plugging and abandonment
costs. To mitigate these risks, I recommend
the acquiring company hedge the bulk of
its PDP production above the operational
break-even cost, including anticipated
capex and debt service levels.
In addition, buyers can anticipate a
50/50 capital structure pro forma for any
property acquisition. This will give the
acquirer the most favorable terms. A second lien or subordinated debt is given
more scrutiny because of leverage guidelines issued by the U.S. Treasury Department's Office of the Comptroller of
the Currency (OCC) earlier this year.
While it is nearly impossible to finance
acreage-only acquisitions with no asso-

American Oil and Gas Reporter - May 2016

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