The sparse capital available to the oil and gas sector is resulting in empty bid rooms, according to Bryan Sheffield, who’s built another portfolio after selling his Permian Basin-focused Parsley Energy in 2021 for $7.6 billion, including debt.
Some E&Ps might be poring over the maps, logs and production data, but “they don’t have any money lined up,” Sheffield told attendees at a Westwood Salient conference in Houston in November. “They're trying to raise money on the fly.”
Sheffield’s new E&P, Formentera Partners, has built a portfolio in the Bakken, Anadarko and Permian basins as well as the Eagle Ford Shale and the conventional Gulf Coast via three funds to date. The company’s focus is on harvesting production from pre-existing wells.
Sheffield is trying to be upfront when making deals, however.
In a look at a property in West Texas, Sheffield warned a seller, “You're not going to like my deal. It's going to be PV-18 on PDP.”
Sheffield’s small business development team worked it for six weeks anyway. They came away emptyhanded. “So we wasted our time. And I said, ‘No more. Call every bank for teasers. The sellers need religion. They need therapy. They need to find out through a process where the bid/ask spread is.’”
Sellers will come back with “No, we can't do the deal. Can you move higher?” to which Sheffield replies, “No.” So the seller asks, “Can you go up like 5%.”
Again, the answer is “no.”
Sheffield’s bids don’t change because, “I know that no one with real money is in the data rooms.”
Some asset marketers are coming around, though, he said. “I think the banks have smartened up a little bit. Over time there have been more failed processes than you could ever imagine.”
A couple of brokers remain adamant in their views of properties’ current market values. “But they're going to [come around] eventually. All you're going to do is upset your seller by promising a market that isn’t there. No one's going to pay you.”
‘It’s okay to lose’
Sheffield lost a deal to a public operator willing to pay PV-12 and he either had a different plan for the property or didn’t “know where the market was.”
In the Formentera model, its business model is built to lose bids if necessary, he said.
“It's okay to lose. I hated to lose at Parsley, but I'm fine to lose here [at Formentera] because there's no reason to overpay.”
To date, Formentera has amassed 480,000 net acres, 40,000 boe/d and 1,500 wells plus an additional 832 PUDs that Sheffield said “I got for free” and are HBP by active wells. It’s currently holding back on developing those. “We're warehousing them. We're going to be patient because we have the flexibility.”
Its first fund, raised in 2021, is a 15-year fund. Fund II, raised in 2022, is built for 10 years plus three one-year options.
“We underwrite each asset as if we're going to be the last owner.” The nature of the property is that “in three years, you’ve made your money back.”
The largest dividend is in the first year; the second largest, the second year; and so on. “Now at the end of 10 to 15 years, I do believe times will change and local operators will likely roll assets up.”
And “what do we care if selling at PV-25 in year 12? We've already made two times our money and now we're selling at PV-25.”
The firm also has a Formentera Permian Fund that has producing assets in the central Midland Basin. It was raised in 2022.
The Houston forum’s host, Westwood Salient, is among investors in Formentera’s Fund I and Fund II. Greg Reid, president of real assets, not there are “not many bidders for energy assets today.
“There's limited competition. The prices are low; the valuations are low. That's exactly what we want as investors.”
‘Need this energy now’
Sheffield said when he restarted after selling Parsley, “everyone thought that was crazy.” The common view, he was told, was, “How long do you think this [oil business] is going to last? We're going to plug all these wells.”
The way Sheffield sees it is “we're not going to plug the wells but maximize the potential of these wells. These wells across every basin have a lot of life left—between 30 and 40 years.
“So even if we stop drilling, we still have this huge life of cash flow around the United States.”
The group thinking out there is that “fossil fuels are doomed and are going to be done by 2030. Tesla and other alternative energies are going to run us off the map,” he said.
But everything else Sheffield sees points to a long future for hydrocarbons.
Underserved populations are doubling, such as in Africa and India, for example. “They need this energy now—affordable energy,” he said.
The money well runs dry
The landscape for capital has changed dramatically from when Sheffield took Parsley public in 2014. One banker “always said, ‘Hey, if you want to start over, come to us.’ So I started over, went back to them and [others] and all of them said, ‘We love that you called, but we have no money for energy.’”
Skipping the broker and raising money directly from investors is more challenging today, too. One of them, “the energy guy of [a university endowment] said, ‘No, we've moved away from . energy investing,’” Sheffield said.
“Think about it: He should be worried about his own job. He's the energy guy.”
Sheffield is finding some pension fund uptake, though, and money is flowing from family offices. Formentera’s Fund II was oversubscribed with $828.5 million in commitments.
The target had been $600 million. Investors also include a couple of asset managers, insurance companies and many registered investment advisers. Eaton Partners, a unit of Stifel Financial Corp., served as placement agent.
“The family offices—they like the contrarian view and [oil and gas are] still contrarian, even at $75 oil and $3 gas. You're like, ‘Wait, it's not contrarian anymore.’
“But it is because of the lack of capital in the system.”
What's wrong with the property Formentera’s picking up? Simply, “they’re fossil-fuel assets,” he said. “So I'm back in this space and I started Formentera because there are so many opportunities.”
The disappearing banker
Sheffield presented a slide in the Westwood Salient program showing Parsley’s bankers during its seven-year run and their status today. A logo-laden column of 37 has evaporated into a few names.
Credit Suisse no longer exists, for example. Several others have visited Formentera but that’s as far as it’s gone.
Others, including Goldman Sachs and JPMorgan, which earned the largest fee among underwriters of Parsley’s security offerings, “have not been through my office one time. There's nothing for them to talk about.”
Many others are still in oil and gas but only banking with their existing clients. “They're not building a book. They're not building relationships.”
Those with an asset-marketing unit want Formentera as an A&D client, “but we're not going to call them and sell an asset through [them] because they don't bank us and support our business.”
An attendee said of the disappearing-banker reference, “You should put this in your Christmas cards.”
Sheffield laughed and added, “I just get frustrated seeing these banks say, ‘Yes, we do lend to fossil fuels’ when the truth is they don't. They’re limited to their existing clients.”
There are at least 30 commercial lenders remaining in oil and gas, according to the Haynes Boone price-deck survey results released Nov. 15.
Sheffield said it used to be that a start-up backed by longtime, top-shelf private-equity firms would automatically get a commercial lender. Today, “the banks aren’t there.”
“They don't care who you are, [suggesting,] ‘We've got to know that you've made money through small increments.’ And that's the same thing they're all saying.”
Then that might not be enough either. Sheffield has a proven track record but, with a longtime Texas lender to oil and gas “we were on the one-yard line to sign a lending deal,” he said.
“They pulled out.”
As for capital from PE firms that had invested 100% of former funds in start-up E&Ps, they may still in the business, but a growing share of funds are migrating to alternative energies.
“You can see how the whole space is changing — the money is changing.”
He saw it as an opportunity. When investment bankers, asset marketers and commercial lenders weren’t calling him back or did but said, “We can’t do fossil fuels,” Sheffield’s take was “We knew we were onto something.
“We knew we were doing something right because no one else wanted to be in this industry.”
Downspacing will resume
Production degradation due to downspacing “is kind of a bad word right now in the industry,” he said. But it works “and I do believe downspacing will be considered again when we have higher quality prices.”
A well on 660-ft spacing produces an expected EUR. Landing two wells, each on 330-ft spacing produces an average of 75% each of the 660-footer’s expected EUR — or 150% combined. Simply, “you need a higher commodity price to get similar returns,” he said.
He predicted that moving laterals closer together will reappear in quarterly conversations and news releases again, “but if I said ‘downspacing’ to a bunch of public investors right now, they would just start throwing food at me.”
“They do not want that.” They want up-spacing instead. “And, obviously, consolidation.”
He also expects investors will begin to support the E&P growth model again, departing from a harvest mode — underway since 2018 — that demands free cash flow be paid in dividends rather than reinvested.
“The growth model will come back,” he said, but “I think we'll be a little more disciplined than what we did the last time around.”
The next inventory
Northeastern public money managers in New York and Boston see operators “ripping through inventory.” Sheffield expects that in five to seven years, all the Tier 1 inventory will be gone. “They're going to move to Tier 2.”
The next frontier? International. “There are shales around the world,” he said. “They're all sitting there. It all depends on which country you want to do business with.
“Argentina has a great play [in the Vaca Muerta], but they're known for nationalization.”
In his newest venture in Australia, Daly Water Energy and Daly Waters Royalty, Sheffield has a large foothold in a tight-gas play in the Beetaloo Basin in Australia’s Northern Territory. (Daly Waters is a town in the basin.)
Sheffield made the deal to sell Parsley in October 2020, closing it in January 2021. Then he turned to the Beetaloo. “The geology and the logs are just like in the Marcellus and Haynesville,” he said.
He is also invested via Australia-listed operator Tamboran Resources. Helmerich & Payne was enlisted to invest and to bring a modern-tech Flex3 rig to the play.
“So the service companies are buying into the play,” he said. “We need more.”
Also, APA Group, a leading energy infrastructure company in Australia, is evaluating a potential investment in a midstream deal.
The areal extent is one-sixth that of the Marcellus and the same as the Midland Basin. A half-dozen horizontals were landed by others in the past, but with 4.5-inch casing, Sheffield said.
“That's not what we do in the United States. We're running 5.5-inch casing. We saw an opportunity to apply a modernized well design and frac to this play.”
Also, well completions had been with gel, which was tried uneconomically on gas shale in the past century until wildcatter George Mitchell tried a slickwater job in the Barnett Shale in the late 1990s. Making the wells horizontals launched the shale revolution.
Tamboran expects to complete Shenandoah South 1H, its newest horizontal, in December 2023, using 5.5-inch casing and slickwater.
“You can't get a high enough pressure through 4.5-inch casing,” Sheffield said. “You need higher pressure to break up the rock.”
“That’s what has delayed the play. The right services and the right recipe will get the job done.”