A&D Intelligence

Upstream producers have been waiting with held breath in dreadful anticipation of the feared borrowing-base redetermination season. This is when lenders will evaluate credit limits based on year-end price decks—price decks some 70% lower than at the last bi-annual reviews when commodities were high flying mid summer.

Now, they’re here.

Many E&Ps with high balances are in for a fiery ride, and some simply won’t survive it with anemic cash flows and no where else to turn for liquidity.

Delta Petroleum finds itself in such a battle. Year-end 2008 the Rockies explorer was fully drawn on its $295-million facility with $65 million in the bank. Following a February redetermination, it found itself $140 million in arrears and has until June 15 to come up with the funds. The company says it will pursue joint ventures and asset monetizations, but the outlook is slim chances at best.

Delta is not alone. Others facing redetermination firestorms include:

• Edge Petroleum—Knocked to its feet following the busted merger with Chaparral Energy, the company reports it is on the brink of bankruptcy following a redetermination of its credit facility, resulting in a $114-million deficiency. It hired Akin Gump to find strategic alternatives for its mostly South Texas assets. May 15 is its drop-dead date.

• Crusader Energy—The newly public Oklahoma City producer came up a mere $5 million short following a review, but $5 million is a lot of greenbacks if you don’t have them. The company with assets in the Midcontinent and Bakken play hired Jefferies & Co. to seek strategic alternatives.

• Energy Partners Ltd.—Borrowing base plunged from $150 million to $45 million, leaving a $38 million deficit. It hired Parkman Whaling as financial advisor. CEO Richard Bachmann resigned. Its assets are onshore Louisiana and Gulf of Mexico.

Others, like Gasco Energy, are foreseeing bad news ahead and getting a head start before their review by trying to raise cash through the sale of assets. Meridian Resources is considering the same.

Guggenheim Partners managing director Tim Murray says that in the current environment with bid/ask spreads still far apart and credit largely unavailable, “unless you have equity or are swapping paper for the assets, it’s going to be very difficult to generate the proceeds to pay down your borrowing base.”

If you’re leveraged to the hilt—or maybe just half way—hang onto your hat. A hot wind is headed your way. And assets will fly like the firestorm it is fueling.

Have you seen The Wall Street Journal recently? It’s now sporting a sports page. Go figure. A financial newspaper lowering itself to covering sports, and in the traditional—not business—sense.

Have advertising revenues sunk so low as to need to entice additional eyeballs to the storied business pages? Have all the Wall St. bankers canceled their subscriptions now that their salaries have evaporated to a mere $500,000 a year? Does TARP forbid advertising? Do elite WSJ advertisers even care about the average sports-loving Joe Schmoe and his little earnings demographic? Does Rupert Murdoch just want to get his morning dose of Yanks regardless of which of his dailies he picks up at breakfast?

Considering that A&D Watch newsletter diligently and comprehensively covers oil and gas dealmaking, and all of the business-development folk are on vacation these days, we’ve decided to add a section titled “E&P A&D Sports” to the venerable blue newsletter.

While all the A&D dealmakers are taking a BD rainout amidst economic storms, we’ll put together a softball league, golf circuit and tennis matches and cover the results in the publication. At the A-Dcenter.com website, we’ll post up-to-the minute stats and online interviews with all of your favorite A&D stars.

“XTO Stallions look to match win-loss record to buy-sell record.”

“Asian shelf players sweep private independents in GOM Invitational.”

“Petrohawk birdies to clinch Haynesville Classic, losses ball in 12,400-foot-deep hole.”

“Rockies matchup between Oxy, Bill Barrett canceled due to ticket price differentials.”

“Chesapeake JVs with opponents to take 66-75% win in all tournament matches.”

It’ll be great reading and give the acquisitions teams something to do to relieve the boredom while the bankers get their act together. As banks are hoarding their cash from new dealmakers, maybe they’d like to sponsor some team jerseys instead.

Slow times call for drastic measures. If The Wall Street Journal can do it, we can do it better. And who knows? Maybe a deal will get done somewhere around second base and we can report on it.

Plains E&P has revealed that earlier this month they amended their Haynesville JV deal with Chesapeake Energy to allow them to opt out of half of the deal. By the end of June 2010 for a cost of $800 million, Plains can bust 50% of the 110,000 Haynesville acres they acquired in July 2008 from Chesapeake.

Would they do it?

According to Calyon Securities analyst Jeb Armstrong, not likely. “We believe that PXP would only exercise the option in a doomsday scenario, namely if it were facing a liquidity issue and would not be able to cover its entire $1.65 billion obligation to Chesapeake. The economics of the Haynesville Shale are among the best of any onshore play in the U.S. It is extremely unlikely that PXP would choose to exercise the option in order to redeploy capital to a more prospective area or to another JV in the Haynesville with more attractive terms.”

Plains has already paid Chesapeake $1.65 billion up front in cash, with an agreement to fund half of Chesapeake’s 80% share of costs going forward until an additional $1.65 billion is paid. The option to beg out of 55,000 acres values the acreage at $14,400, or roughly half of the $30,000 it paid when it entered the JV, says Armstrong.

Why would Chesapeake give them an out once the deal was inked? Consider that Chesapeake CEO Aubrey McClendon and Plains CEO Jim Flores are friends going way back, and friends take care of friends. The out is simply a safety valve for the aforementioned “doomsday” just in case.

Would Chesapeake care if they did opt out? Again, not likely. The break-up deal involves no cash paid and only funds promised. Chesapeake already has its up front and is still getting it’s huge carry through mid 2010. Natural gas prices will probably rebound enough in that period to create enough cash flow to lessen the lost carry.

And Chesapeake will just do it again. I wouldn’t bet against them packaging up those 55,000 acres from Plains, throwing in a few more from their ongoing lease program, and JV a prime piece of the Haynesville to another eager player with cash. It could happen.

The present marketplace for upstream oil and gas assets is “very slow” as the only sellers are companies that must sell because of liquidity needs or to clean up their balance sheets, says A&D investment banker Rob Bilger, managing director with Tristone Capital.

“It’s a very slow marketplace right now. A number of companies are looking at company acquisitions and merger potential because of relative valuations and a scarcity of quality properties on the market.”

Bilger says Tristone was anticipating the most active A&D market ever for the fourth quarter as 2008 blazed along at a record-setting pace through the first three quarters of the year, with Tristone closing on transactions in the U.S. totaling more than $7 billion through the first nine months. But that all changed when the credit markets went into turmoil in September.

“When the cost of capital increased and capital availability evaporated, the markets just shut down,” he says. Tristone capped its year on Sept. 30 with an $873-million cost-adjusted deal for Cordillera Energy Partners, which sold Buffalo Wallow and East Texas/northern Louisiana assets to Forest Oil Corp. That deal is the last significant A&D transaction that has closed, other than Statoil’s joint venture with Chesapeake in the Marcellus.

In addition to a lack of capital availability for doing deals, he says the precipitous fall in commodity prices since the summer has left an enormous overhang of failed property sales. He estimates transactions valued at more than $8 billion either failed or were pulled from the market in fourth-quarter 2008.

“Companies could either continue their offerings with a major gap between seller expectations and what buyers were willing to spend, or they could just pull the property.”

That disconnect has left a fallout of frustrated sellers, some that had anticipated selling to take advantage of high commodity prices or  beat an anticipated increase in capital gains rates, and those that need to sell to fund capital expenditures.

Bilger sees the asset drought lasting at least through the first quarter and possibly longer.

“It’s all about capital right now-the lack of capital availability or the high cost of capital. We’re seeing some debt offerings get done now, which is encouraging. A couple of companies have recently been able to raise substantial public debt.”

Devon Energy Corp. raised $1.2 billion in notes at 6% in January and El Paso Corp. raised $500 million at 15% in December.

Debt markets “have opened up a bit from where we were just a couple of months ago,” says Bilger, “but it’s still a relatively high cost of capital. Banks are still reluctant to get aggressive with their lending for property acquisitions.”

January brought renewed activity from potential sellers at Tristone. “These are companies that feel compelled to sell to fund either high-return capital projects that they wouldn’t be able to otherwise or make debt repayments. These asset packages likely won’t be available until the second quarter.”

Companies will also soon face added pressure from banks as borrowing base redeterminations based on year-end reserves and price forecasts squeeze cash availability, but Bilger believes the fallout will be limited. “We’re not going to have significant forced sales, but I do think there will be pressure from the banks to reduce debt and cut expenditures.”

So will borrowing base redeterminations throw a flood of assets into the marketplace as cash-strapped companies look to raise additional funds?

“There’s a mixed view on that. I’ve been told by a lot of people in the industry that we’re going to be swamped this year with property divestitures, but we haven’t seen it yet.”

Those that do sell will first look to divest their conventional assets to focus their financial resources in the new resource shale plays. “Companies are going to clean up their portfolios first by selling their non-strategic traditional assets and prioritize expenditures on  their new resource plays because of higher rate of return drilling and the need to hold the leases.”

Bilger notes a polar shift occurring in buyers and sellers.

“The private companies—especially the private equity-backed companies—were the big sellers the past couple of years. Buyers have been the more aggressive mid-size and large independents. Now those roles are reversing. The highly leveraged independents are going to be sellers going forward, and companies with access to private equity and some debt capacity are going to be the  likely buyers.”

He says Tristone is talking with private companies looking opportunistically at the marketplace and with well-funded independents and majors that have strong balance sheets. “There are definitely buyers out there looking for attractive strategic transactions.  However, they want to be careful that they don’t act too soon and that they wait for the right opportunity.”

This environment could encourage companies to seriously consider mergers.  With corporate valuations at their lowest levels in years, companies in strong financial positions see opportunities to buy companies to acquire attractive assets at a reasonable cost.

“They see synergies available by combining organizations and cost structures. It may be that the target company is over levered and doesn’t have enough cash to exploit its assets, and the acquiring company with a stronger balance sheet can do so. There are certainly people looking at potential M&A transactions.”

What will 2009 hold for the A&D market? “It’s a bit early to tell,” he says. “It depends on how prices react and particularly how credit markets respond. If prices rebound and stabilize and the credit markets continue to improve, then the second half of 2009 could be quite active for A&D.”

When energy investor and Tulsa billionaire George Kaiser stepped up to the plate and slammed nearly $500 million into cash-strapped producers Chesapeake Energy Corp. and SandRidge Energy Inc. this past week in two separate transactions, his home-run confidence may have defined the turning point for the energy industry in the ongoing financial maelstrom.

Kaiser’s private-equity fund Argonaut Private Equity, with more than $3.5 billion under management, first bought South Texas production from Chesapeake in a volumetric production payment for $412 million. It followed with a $50-million private transaction with SandRidge CEO Tom Ward for some of his personal stock in SandRidge.

The Wall Street Journal reporter Ben Casselman spoke to Argonaut managing director Steve Mitchell, who said, “Mr. Kaiser believes many energy stocks are trading at prices about as low as they’re going to get. The anchor is dragging bottom; he feels there are some good buying opportunities.”

Carl Tricoli with private-equity firm Denham Capital, as quoted by The Wall Street Journal, says, “Seeing someone like George Kaiser involved would reinforce the notion that this is the time to be looking at opportunities.”

The Chesapeake deal, which closed on Dec. 31, helped CEO Aubrey McClendon live up to his promise to investors to get the deal done by year end, although a few dollars short of his targeted $450 million. During the heady days of the commodity price run-up, Chesapeake spent money like a drunken sailor, according to JPMorgan analyst Joe Allman, but during 2008 was able to raise some $12 billion in asset sales and credit lines to pull out of the nose dive to avert catastrophe.

A few days following, Kaiser, also the chairman of private Kaiser-Francis Oil, bought a 5% stake in SandRidge representing a 23% chunk from Ward’s personal stock, who had to sell for “debt service and tax-planning needs.” Of note, in October Ward also sold his personal working interests in SandRidge-operated wells back to SandRidge for $60 million. Ward, too, was a co-founder of Chesapeake with McClendon in 1989.

Tudor, Pickering, Holt & Co. analysts like the combo, calling it a “vote of confidence” that Chesapeake and SandRidge assets are “pretty solid.” Kaiser is “a well-regarded energy money maker” and historically has “knocked the ball out of the park in both commodities and E&P business. We’ve got a savvy local buyer stepping up.”

The end of the downturn is near, if you believe a half a billion dollar swing by an experienced slugger.  Maybe his move will be a catalyst to get money flowing back into the upstream energy sector void.

Steve Toon, Editor, A&D Watch; The A&D Center, www.A-Dcenter.com; Contributing Editor, Oil and Gas Investor; www.OilandGasInvestor.com; stoon@hartenergy.com

According to Ernst & Young, if you’re an E&P company duking it out in today’s turbulent economic environment, you fall into one of three categories:

• Good shape: tons of cash, total flexibility, in a position to be opportunistic
• In trouble: seriously stressed as you manage year-end balance sheets
• Cautious, but OK: pulling back capital programs, looking at cost reductions, in the majority

To help you get a gauge on where you are, E&Y has created the “Stress Pendulum” that swings from a positive “cash flow” on one end of the scale to “cash burn” at the other.

For a more detailed view, click here: Ernst & Young’s Stress Pendulum

Your company is “performing” if you are in a position for acquisition opportunities, have portfolio optimization and supplier stability.

You are “underperforming” if you are facing market reassessment, evaluating working capital, managing liquidity and reducing costs.

You are “at risk” if you are juggling stakeholder management, have asset impairment and must divest assets.

You are “insolvent” if you are forced to close business units, are undergoing capital restructuring or, worst, under the supervision of a court!

Hope you’re in the green.

Steve Toon, Editor, A&D Watch; The A&D Center, www.A-Dcenter.com; Contributing Editor, Oil and Gas Investor; www.OilandGasInvestor.com; stoon@hartenergy.com

Chesapeake Energy Corp.’s mea culpa by cancelling its announced distribution agency agreements and cutting the planned shelf registration by half in a week’s time is a fast act of strategic response in a fluid environment. The retrench is merely a minor adjustment for a company caught in a cash pinch and ferociously fighting its way out of a predicament against impossible odds.

CEO Aubrey McClendon concedes the market response to the filings were “obviously very negative” and that management underestimated the response. “Our intent was to create broad financial flexibility for an uncertain economic environment and commodity market environment over the next few quarters. In retrospect, we made a mistake.”

It was only a mistake because it didn’t work. The strategy to raise $1.8 billion in equity was actually quite shrewd for keeping the cash flowing for a company addicted to running and gunning, and facing a $2.3-billion budget shortfall at $6 gas. Problem was, investors didn’t like the idea of their shares being diluted and dumped them fast, causing a share value tank from $20 to $11 in the ensuing week.

So, short of that source of capital, liquidity remains an issue at Chesapeake. Analysts at Tudor, Pickering, Holt & Co. suggest the pre-Thanksgiving shelf offering on the heels of a $1.25-billion sale to StatoilHydro illustrates the company may need even more cash NOW to get it through the fourth quarter. It also illustrates that the debt markets are still closed to Chesapeake, bought deals are still unavailable (”ibanks have no money”), and the asset sales market is very, very weak. “Liquidity could be worse than expected.”

But Calyon analyst Jeb Armstrong analyzes the spector of Chesapeake facing bankruptcy as remote. Current snapshot: Chesapeake is sitting on $1.5 billion of cash in the bank and should end the year with $2 billion to $2.5 billion when VPP#4 in the Anadarko Basin closes. Switching gears and transforming the South Texas asset divestiture to a VPP could raise an additional $450 million. Armstrong says more VPP sales over the next two years along with the sale of an interest in its midstream assets (ongoing) could even double its cash balance. If the credit markets begin to thaw, he says, Chesapeake would likely use the cash to begin paying down the $3.5 billion balance on its credit revolver. Now, he chides, “management must show that it can maintain financial discipline and wean itself from capital markets.”

In lieu of not having the potential cash from the equity issuance, Chesapeake has instead followed the hard march of its peers—painfully cut 2009 capex by 31% to match cash flow for a total capex of $3.8 billion, reducing growth forecasts to 5-10% in 2009 and 10-15% in 2010. Significantly, it also whacked its leasehold and producing properties acquisitions budget by 78%, or $2.2 billion over the next couple of years.

So, we can expect Chesapeake to be mostly quiet this coming year in acquisitions and to tend to the drilling while the economic markets shake out and investors regain their confidence in the company.

Yeah, that’s believable. While I don’t have an inkling what it might be, we can always count on Chesapeake to push the margins to produce some excitement. McClendon will pull another rabbit out of his hat, and we’ll be off to the races again.

Steve Toon, Editor, A&D Watch; The A&D Center, www.A-Dcenter.com; Contributing Editor, Oil and Gas Investor; www.OilandGasInvestor.com; stoon@hartenergy.com

As if it isn’t bad enough out there already, cash-strapped E&Ps have a new boogey monster to fear: borrowing base rederminations.

While companies are pulling in the reigns to match capex to cash flow, every drop of liquidity matters to survival. And as redeterminations come due, scuttlebut has it that a surprise looms for E&Ps dependent upon credit.

Suddenly, feeling the pinch themselves, lenders will pull in their horns on valuing proved undeveloped locations.  Banks are expected to attach a valuation on PUDs of… zero—or close.

That’s right. You get your proved developed producings, but nada much mas. Because of tanking commodity prices, what was considered a PUD yesterday might not be deemed commercially viable today, and banks won’t be able to lend against it depending on their price deck and desired return on capital.

So what’s it mean? It means less liquidity than you first thought if indeed you are liquid. And it means many companies will be caught over the borrowing base as the line is adjusted down. And you’ll owe the piper.

Of course, for most caught overdrawn there simply won’t be cash or equivalents available. Assets will come flying loose to pay the bill. For those that can’t meet the call, blood will flow. You can look to buy their assets out of bankruptcy.

Steve Toon, Editor, A&D Watch; Contributing Editor, Oil and Gas Investor; www.OilandGasInvestor.com; stoon@hartenergy.com

While company after company cuts capex in the midst of the present financial storm and are thinking more about selling assets than buying them, GeoResources took a look at its balance sheet and decided, “Hey, we’ve got game.”

The company declared that it had no intentions of cutting its capital budget like so many others and that it could continue at its present burn from cash flow with oil at $50 a barrel and gas at $5 per Mcf. That said, GeoResources says the “rapid and steep reductions in commodity prices has made the acquisitions market more attractive and accordingly is increasing efforts to pursue asset or corporate acquisitions.”

Deal them in.

GeoResources states that acquisitions, “when favorably priced,” are an integral part of its business strategy and, as most of its acreage is already held by production, “drilling and development can be deferred if favorable acquisitions are located.” Sounds like a case of acquisitions over drillbit when assets go on sale.

The company is working with a $100-million borrowing base and believes it can acquire incremental capital through partnerships or corporate finance.

CEO Frank Lodzinski says, “In spite of the recent steep decline in commodity prices, we are forging ahead with our drilling programs and are continuing our plans. We expect to continue to develop our assets and expand our acreage and prospect inventory, particularly in this environment when many are cutting back and acreage and asset valuations are declining…Our borrowing capacity and access to additional capital can be used to fund acquisitions of acreage, producing assets or corporate entities, should attractive opportunities be located.”

Steve Toon, Editor, A&D Watch; The A&D Center, www.A-Dcenter.com; Contributing Editor, Oil and Gas Investor; www.OilandGasInvestor.com; stoon@hartenergy.com

If you need money to do a deal in today’s economic environment, it’s quite expensive or just darn impossible, says Dan Pickering, co-president of Tudor Pickering Holt & Co. Securities Inc. “Capital is going to be very tough to come by in today’s environment. The music has stopped when the markets are rationing capital and its hard to get money.”

Pickering made his comments at Societe Generals’s quarterly luncheon in Houston recently.

Specifically, the overall stock market hasn’t done an IPO since August—anybody, not just energy. No one has been able to do a debt-deal in the last four weeks unless they’re A-graded. Commercial paper is out there but very difficult. And private equity, wherefore art thou?

“There’s a ton of it and they’re ready to go to work,” says Pickering, “but probably not for three to six months. Prices are coming down; the market is coming their way. Private equity is going to step up, but not at today’s prices. We still have a bit of a mismatch between buyer and seller expectations.”

Cash is king when credit is scarce. “If you’ve got money you’re in the drivers seat. It’s definitely becoming a buyers’ market–but that implies somebody wants to buy.”

So where are the buyers, those cash-flush companies eager to pounce? “Most of the buyers are waiting because they feel they can get a better deal, which is freezing transactions. A lot of guys aren’t (buying now), but they’re ready.”

Pickering recounts speaking with a company recently that told him, “I haven’t seen a deal I’ve liked in two years, and I just saw one last week that I’ll think about doing—but not now.”

And while shale plays are still valuable, “they cost money in the near term and they don’t generate money in the near term. Everybody that owns acreage in the Haynesville, the Fayetteville, the Barnett and the Marcellus love it, except it doesn’t generate any cash.” He says no one wants to put any money into acquiring acreage at this moment in time, bringing down acreage and property prices just about everywhere.

That’s because everybody that was spending more capex than were generating free cash flow are now whacking at capex budgets with machetes. “You can’t just spend more than you’ve got. Everybody’s living within their means: It’s the new mantra with public E&P companies.”

(For a look at companies that are flush with cash and those that are gasping for cash, check out Pickering’s chart “The Music Has Stopped.”)

Ironically, he says, in today’s world buying reserves on the public market is cheaper than buying in the private market. Proved reserves are trading like oil is going to be $50 to $60 forever and gas is going to be sub-$6. No credit is being given in net asset values for the Haynesville, Fayetteville or any other shale play.

“That’s probably too extreme, but it’s where people are because no one wants to take a risk. We’re not going to hit bottom until commodity prices stabilize.”

In the meantime my-cheap-stock-for-your-cheap-stock deals may become apropos, he suggests.

And will the majors take advantage of fire-sale valuations to return to North America? “It feels like they ought to,” he says. “BP has been spending money a couple of billion at a time, and now there are companies that are worth a $2 billion that were worth $10 billion a couple of months ago.” He points to Chesapeake Energy, whose stock price rose 9% on the rumor that BP Plc would acquire it.

“This change has come about very quickly,” Pickering says. “Maybe it changes quickly again and gets better fast.”

Steve Toon, Editor, A&D Watch; The A&D Center, www.A-Dcenter.com; Contributing Editor, Oil and Gas Investor; www.OilandGasInvestor.com; stoon@hartenergy.com