Private equity-backed producers are still building positions in the Permian Basin, but the size and pace of individual transactions will be smaller and slower than during the first decade of the shale boom. The difference between the seven largest Permian producers and the companies looking to establish a winning position comes down to the ‘haves’ and the ‘have nots,’ said Chris Carter, managing partner at NGP Energy Capital Management.
Hart Energy queried top private equity firms invested in the Permian about what’s next for the most prolific shale play in the U.S. This interview with Carter is the second in a three-part series.
This interview was edited for clarity and length.
Deon Daugherty: Taking a 50,000-ft view, what is the state of private equity in the Permian?
Chris Carter: We're coming out of a cycle of exits when a lot of the scale positions that had been built over the previous five to 10 years in the Permian were exited. That’s coming out of a period from 2017 through 2021, where it was a tough market to sell, at least at valuations that were interesting.
So a lot of those scale positions, where companies had drilled tens or hundreds of horizontal wells and built scaled acreage positions, were ready for exit, and as the market improved, you saw the wave of A&D activity—over $300 billion of A&D since 2023 that occurred—so a lot of those scale positions got sold out today.
I think you see fewer private equity-backed companies in the Permian. There are still many, and they're trying to reload. That’s the position that we've been in over the past couple of years. As private equity sponsors and their portfolio companies try to rebuild scale positions, I would say it's much harder today to do.
According to Enverus, if you look at Tier I locations in the Permian, 80% of the Tier I locations are owned by the seven largest companies in the basin Exxon [Mobil], ConocoPhillips, Diamondback [Energy], Chevron, Oxy [Occidental Petroleum], EOG [Resources] and Devon [Energy]. So it's kind of a tale of ‘the haves and the have-nots’ right now in the Permian. And as all these sponsors are trying to rebuild, it's harder.
On exits, you're still going to see large sales by private equity-backed sponsors, but I think the pace, and we've seen that in the past six months, it's just going to be slower because a lot of those scaled positions have already been sold.
And I think it will take a few years for a lot of these sponsor-backed companies to rebuild the scale and mature their business plans to a point where they'll be ready to exit.
DD: Will private equity deploy in different ways in the Permian or might it go to other basins? What’s the plan for what’s next?
CC: It depends on the sponsor and the team. You've certainly seen several sponsors deemphasize the Permian because of valuations and competition and a lack of available Tier I inventory. You’re probably not going to see as many splashy announcements on the buy-side. Our portfolio companies are building scale through lots of smaller transactions that don't necessarily get announced, and then they are building over time.
I think that in the Permian, because 80% of the inventory is owned by the seven largest companies, the strategies include farm-ins and drilling-to-earn with a lot of those large companies.
Greenlake [Energy] in our portfolio run by Matt Gallagher has been able to do several farm-ins with the majors that, you could argue, have too much inventory. They have decades' worth, so it's not as economically efficient for them to hold those locations for 15+ years when they could have a sponsor-backed team like Greenlake that can bring value forward and allow them to share in the economics of those locations being drilled immediately. So farm-ins are one source of deal flow within the core of the Delaware and the Midland Basin.
The other strategy that we see in our portfolio is expanding the core in both the Midland and the Delaware basins. What I mean by that is, being fast followers, drilling wells on the eastern and western edges of both of those basins, and then also zones that are being developed within the core of the Delaware and the Midland basins that historically weren't as densely developed but well results have kind of proven up a high rate of return locations. Oftentimes private equity-backed sponsors are the first companies to really capitalize on those trends, to expand zones in different parts of the play, so that that's a strategy as well.
And then, you'll still see private equity-backed sponsors acquiring core inventory. I just think it's a lot harder given where valuations are right now. Big picture in the private equity landscape, PDP is becoming more competitive with the use of ABS financing structures, and then when you look at core drilling locations, especially in the Permian, I think there's a real scarcity premium that's being paid both by public and private companies, which makes it more competitive to acquire within kind of the “core” of the Midland and Delaware basins.
Where private equity companies can be more successful in those bids is when they have a truly differentiated view on spacing and productive zones that allow them to underwrite more total drilling locations. Otherwise, it's a cost of capital competition and public companies generally should win that battle.
DD: Tell us about the IPOs that we’re hearing about lately. How do you think that public markets are reacting and are they truly reopening to IPOs?
CC: At NGP, we have a history of being very active in the capital markets when we think there are clear advantages to doing so. From 2014 through 2017, we took eight of our businesses public, so we've been very active historically.
I would say the capital markets and the IPO market have opened back up since 2023 after being essentially shut down for the most part from 2018 through 2022. However, the combination of value arbitrage from private to public and the liquidity available for small-cap public companies is not as interesting to us as it has been in past cycles. What I mean by that is, you can get public today—that market window is open—but I think it's a harder value proposition to be a small-cap public company today.
I will tell you that if we saw a clear path to build a scaled business of over $10 billion of enterprise value in the public markets with real liquidity in the stock, that would be more compelling to us.
Part of the reason is the market has been pretty efficient over the past couple of years on the exit value you can receive in cash and stock from public companies that have healthy balance sheets that have access to capital. The cash A&D market has been healthy and usually when you're considering an IPO, you're weighing the trade-offs between what you could achieve in a cash exit and what you could achieve in the capital markets through an IPO.
That trade-off hasn't been as compelling in our view over the past couple of years in the IPO markets, but we're always open-minded as those cycles continue to change.
DD: How are LPs responding to oil and gas fundraising, especially now that the ESG movement seems to have slowed down?
CC: Investor demand has increased over the past several years because returns have been really strong. The past couple of years have been more challenged for broader private equity, in terms of returns but especially in terms of distributions to LPs, and energy has outperformed over the past several years, both on returns and distributions to LPs.
So I think interest level is higher. However, there still can be a bit of a red-state, blue-state dynamic in terms of which pension funds have the political flexibility to invest in oil and gas, so that dynamic is still in play, but I would say overall demand from LPs for energy is certainly higher than it was in that 2018 to 2022 period.
DD: Do the public markets undervalue the oil and gas space?
CC: Valuations for public and private assets have come into a balance that creates more attractive returns for investors than we certainly saw during the shale boom. Oil and gas stocks should trade at discounted cash flow multiples, PE multiples, enterprise value multiples because it's a declining asset.
Most industries don't have a dynamic where you need to reinvest 40% to 80% of your EBITDA to keep EBITDA flat. So without that kind of long-term organic growth profile and low capex reinvestment rate, that's why you live with lower multiples. So, I don't know that they're unfairly valued.
But I would say for investors both on the private and the public side, we've been in an era for the past several years where valuations can allow for attractive risk-adjusted returns, and the other difference is, public stocks for the most part in oil and gas are now paying dividends, which wasn't the case for much of the past two decades.
That provides both a return of capital strategy and an implied return at valuations that are more attractive for public investors.
DD: Looking ahead to consider places to deploy capital, where does the Permian rank and why?
CC: We're still very committed to the Permian. About half of our capital has been deployed in the Permian over the past 10 years, and that's across oil and gas, midstream, and royalties and minerals, where we have a big presence. My hope and expectation is that we'll continue to have a significant portion of our funds invested in the Permian going forward.
DD: How does a portfolio company get past the barriers to entry?
CC: Today a big barrier to entry in the Permian is, you not only have to have the capital availability, but you've got to have the operational expertise and capability to efficiently drill hundreds of wells during the life of your ownership. That means full cube development, which requires a lot of capital and operational expertise. Big picture, running one rig in the Permian is likely $100 million a year of capex. That’s different from five 10 years ago when you had a lot of companies, focused on the acquisition side of the business plan and may only drill a handful of wells before they sell.
Today the barrier is full field development and having businesses that are more opportunistic on exit but aren't aligned toward having to sell in a certain period of time.
So that's kind of how we design our portfolio: trying to buy at valuations that can clear our rate of return hurdles but partnering with management teams that have the track record of operational efficiency. That gives us the confidence that we can go out and drill hundreds of wells during the life of our company's ownership and send back returns to our LPs through free cash flow dividends while we own the assets and be really opportunistic on exit.
That’s the business plan that we're following, and we're still finding opportunity. This is still a basin where small positions can allow for very large capital investments.