The bad old days of minerals and royalties buying was like navigating a massive and ugly spaghetti junction of benches, basins and plays. Where to buy and when鈥攖iming the drill bit was crucial鈥攃ould make or break oil and gas mineral return on investments (ROIs).
As private equity shops entered the shale world鈥檚 minerals market, they have brought far more discipline, since returns in the PE world are prized above all else. And, by now, they have clearly found their bearings. Firms now buy undeveloped acreage that they know, given time, will turn into piles of cash.
NGP, for instance, has deployed more than $1.3 billion in the past decade in minerals as a standalone strategy. Post Oak Energy Capital looks for tangential opportunities alongside its upstream assets. Riverbend Energy Group likewise has amassed roughly 25,000 net mineral acres in the Lower 48 that will throw off cash this year.
Fund managers have learned to navigate the major thoroughfares that run through the Permian Basin, the Eagle Ford, the Bakken and other shale plays. A mix of technology, dedicated minerals teams and partnerships with upstream operators have streamlined evaluation of opportunities into an assembly line of sorts: data, rigorous evaluation and intelligence (or gossip from PE鈥檚 upstream allies).
The major challenge remains finding just the right off ramp, private equity executives said at the World Oilman鈥檚 Mineral & Royalty Conference earlier this year.
Scott Rice, managing partner and COO at Riverbed, said the firm鈥檚 minerals fund has built its position with more than 150 transactions, most of them knife fights, that will have cash flow 鈥渘orth of $100 million in the next 12 months.鈥�
鈥擲cott Rice, managing partner and COO, Riverbed Energy Group (Source: Riverbed Energy Group)
The buying is difficult. But the bigger concern, Rice said, is that the 鈥渇ood chain鈥� for making an exit needs to evolve.
Selling to his peers at NGP, Post Oak or another private equity shop is all good and well, but those deals won鈥檛 generate the optimal return the fund wants, he said.
鈥淲e鈥檙e looking for that food chain鈥攖hose big guys that continue to get big in the public market,鈥� he said.
Since the early days of oil and gas mineral and royalty stockpiling, buyers have become more sophisticated and prodigious in their approach to the space.
Henry May, director at Post Oak, said he sees a continuation of the trend in the 鈥減rofessionalization of mineral ownership鈥� that has occurred, more or less, in the past 10 years.
May anticipates more specialized pools of capital from family offices or dedicated mineral funds popping. And the asset class, in general, is starting to be better understood by the institutional investor community.
Matt Tramonte, vice president at NGP, said the more institutional capital is attracted, the more it will help bolster public markets.
鈥淲e鈥檙e still woefully underpenetrated in terms of institutional or public ownership of minerals, just across the board,鈥� he said. 鈥淚 think we鈥檙e all doing our damndest to break the mantra of grandaddy saying, 鈥榥ever sell your minerals.鈥欌€�
May said that more bespoke investment vehicles will come. But he also remains puzzled by the disconnect between the clear value in low-risk mineral and royalty assets and the way in which Wall Street views them.
鈥淚t is continually surprising to me that the public market for minerals isn鈥檛 bigger than it is,鈥� May said. 鈥淚 mean, it鈥檚 much bigger than it used to be. But it鈥檚 still just a tiny fraction of what I think it should be.鈥�
As a function of the debt and yield vehicles available to investors, 鈥渋t鈥檚 really an ideal asset class.鈥�
鈥淢y hope is that [the] public market, and [the] ultimate exit opportunity, also grows as well,鈥� he said.
For now, everything Post Oak looks at is for life of investment.
鈥淲e don鈥檛 assume that we can exit in a few years when we look at minerals.鈥�
How PE picks its spots
The barriers to buying into the minerals asset class aren鈥檛 terribly complicated. Anyone with a computer and an internet connection can log onto a mineral buying platform.
Private equity firms acknowledge that buying oil and gas minerals and royalties assets isn鈥檛 necessarily rocket science. Unsurprisingly, NGP and its kindred have nevertheless made it their business to fuel their funds with rocket fuel and overload their teams with science.
Tramonte said different strategies have emerged. Some buyers rely on marketing processes, others on ground games. Some are geographic, others basin agnostic.
鈥淵es, anyone can get in and do it,鈥� Tramonte said. 鈥淭here鈥檚 lots of data available. You take a type curve, take a price deck, take an assumption on timing and, boom, you鈥檙e ready to go.鈥�
Naturally, NGP鈥檚 process is vastly more rigorous and precise.
Tramonte said NGP has developed minerals companies鈥擬esa Partners II, Elk Range Royalties, Foundation Minerals II, Wing Resources鈥攖hat each have dedicated strategies.
Tramonte said each is staffed with highly technical engineers and finance professionals that have specialized focus areas. Mesa, for instance, has longstanding relationships with operators in the Haynesville Shale. Foundation is 鈥淢idland [Basin] born and raised.鈥� Wing is laser-focused on the Delaware Basin. Elk Range screens deals rapidly, sticking to a process and framework from which it seldom deviates.
NGP also is one of the most active sponsors in the U.S. of rig activity, so it can rely on what it knows鈥攐r previously owned鈥攖o inform its mineral buying decisions.
May said Post Oak evaluates deals ranging from $80,000 to $30 million. But he allows that Post Oak sees its process as more 鈥渁rtisan鈥� and focused on each individual prospect.
In one transaction, some developmental acreage in the Delaware Basin has been mired in litigation, with the operator and mineral operator at loggerheads over how to develop the asset.
鈥淲e were able to get in and actually acquire that because we had a portfolio company that had a real positive geologic perspective on that acreage.鈥�
Post Oak bought some of the undeveloped acreage, made some trades for longer laterals, then brought to bear other levers, including its service and water midstream entities, to work in conjunction to develop the asset.
鈥淪ometimes it鈥檚 a whole lot simpler and sometimes it鈥檚 even more complex,鈥� May said.
Adding to the complexity is the sheer volume of deals Post Oak evaluates either through its ground game or macerated deals.
鈥淭here鈥檚 just a high degree of deal flow and you鈥檝e got to keep at it鈥攜ou know, those repetitions, to know when something is attractive enough for you to lean in and 鈥� when you get kind of [to] the end of the stage and when you need to just kind of back things off and let things go.鈥�
Riverbend鈥檚 approach to deals is distinct, since the firm is its own dedicated minerals team.
Rice said Riverbend relies on partners for input, including other private equity firms such as EnCap, Blackstone and Kayne Anderson.
But Riverbend鈥檚 analytic deal engine is seemingly based on inherent skepticism. As a deal comes in, it flows to engineering technicians, pre-evaluation, evaluation and then a deal time.
鈥淎ll the time, we鈥檙e trying to kill the deal,鈥� Rice said.
Riverbend uses basinal models and a dedicated team to update permits and activity, which constantly feed an engineering model that鈥檚 indifferent to what Riverbend鈥檚 acquisition side is involved with.
鈥淪o, we鈥檙e very focused on the process,鈥� Rice said. 鈥淲hat can be measured can be improved. Every process, every point in the process, how can it get better?
鈥淭hat鈥檚 how Riverbend鈥檚 been able to consistently deliver outsized returns, is because [of] our approach to the process.鈥�
Rice said the company is always in pursuit of what he called the firm鈥檚 鈥淭rue North.鈥�
White space buyers
Private equity firms have one other ace up their sleeve. They鈥檙e not necessarily looking for the next development to be ready-made.
Rice sees an advantage to buying 鈥渨hite space鈥� where acreage doesn鈥檛 necessarily come with a DUC or even a drilling permit in place. That approach is largely different from upstream A&D, in which PDP, DUCs and a firm sense of inventory are essential to the valuation of a deal.
Buying in, say, Midland County, with three DUCs in place and multiple permits seems almost too easy. The question, however, is how to find it.
鈥淲e鈥檙e all looking for it, and you kind of got to turn every chair over to get that one acre,鈥� he said.
Riverbend鈥檚 process-oriented buying strategy works one mineral acre at a time, with the ability to anticipate that, at some point, which acreage is likely to be developed even without the paperwork and permits in place.
May said Post Oak is also keenly interested in white space areas that are undeveloped for now.
鈥擧enry May, director, Post Oak Energy Capital (Source: Post Oak Energy Capital)
鈥淚n the mineral space, when you look at the actual value of that undeveloped inventory [it] ends up being a lot higher as a percent of the total deal value than when we look at our upstream investments,鈥� he said. 鈥淲e鈥檙e actually looking at very similar upstream investments from where it is in the development cycle.鈥�
Tramonte said NGP also acquires white space acreage, which its operated portfolio companies consistently net up the interest 鈥渂ecause there is that information asymmetry from an operated development schedule perspective.鈥�
鈥淏ut, again, that鈥檚 just being opportunistic,鈥� he said. 鈥淪o, we kind of play across the board within our main fund and the royalty partners fund.
鈥淟ike Henry [May] said, we鈥檙e going to lean on that undeveloped value more and be able to have a relatively long timeframe by which to invest and see that acre go from white space to permit to DUC to being developed.鈥�
May said the vast majority of what Post Oak evaluates from a minerals perspective has 鈥渨ell north of 50% undeveloped value on it.鈥�
The ultimate goal is to find an opportunity that鈥檚 perhaps 20% developed and buy it.
鈥淎nd we want to see it developed 30%, 40%, 50% and then try to find that exit market,鈥� he said. Then Post Oak, like other private equity firms, heads to that still half-built off-ramp that funds keep waiting to open a little wider.