Oasis Petroleum’s (NYSE: OAS) shares suffered a massive selloff earlier this week, giving up almost 20 percent of their value over just two days.
Prior to this plunge, the stock’s more than 40 percent return over the preceding three months made it one of the top-performing exploration and production names this fall, in keeping with its history as a good source of alpha when oil prices and investor sentiment improve. This trading pattern reflects Oasis Petroleum’s leverage and the sensitivity of drilling and completion activity in the Bakken Shale to oil prices.
What precipitated the sudden collapse in the stock?
Oasis Petroleum announced an agreement to pay EnCap Investments LP-backed Forge Energy $946 million for its net 20,000 acres in the Delaware Basin, funding the purchase with cash drawn from its revolving credit facility, a public equity sale, and 46 million common shares issued to the seller. Oasis Petroleum aims to offset this cash component with $500 million worth of noncore asset sales from its legacy position in North Dakota’s Williston Basin, home to the Bakken Shale.
Investors balked at the transaction’s relatively steep sticker price–about $40,000 per net acre for assets in the oil-rich southern portion of the Delaware Basin, an area that shows promise but requires more appraisal and therefore involves more execution risk than the play’s northern portion. Nevertheless, the valuation multiple paid by Oasis Petroleum comes in at the upper end of recent deal flow in the Permian Basin.
The robust valuation multiple associated with this acquisition leads to questions about Oasis Petroleum’s relationship with EnCap Investments and Forge Energy’s management team. Key executives from both sides hail from the defunct Burlington Resources, while Oasis Petroleum itself is one of EnCap Investments’ former portfolio companies.
Whether these relationships gave Oasis Petroleum special insight into the underlying assets or resulted in a raw deal for the company remains to be seen. But the optics don’t necessarily look good, especially on a transaction that many have panned for its valuation.
Moreover, the deal came as a shock because Oasis Petroleum’s management team previously had expressed a preference for bolt-on acquisitions that leveraged its existing scale, expertise and vertical integration in the Bakken Shale.
The company deserves plaudits for living within cash flow in 2015 and 2016 while maintaining its production volumes. This resilience stemmed from cost cutting and impressive operational results from high-intensity completions—longer laterals, proppant loads of 20 million to 30 million pounds, and tighter spacing between stages and perforation clusters. The initial public offering of Oasis Midstream Partners LP (NYSE: OMP) also helped the exploration and production company to strengthen its balance sheet
Oasis Petroleum stuck to its knitting when Permania gripped the US oil patch in 2016. That’s when established players like Concho Resources (NYSE: CXO), RSP Permian (NYSE: RSPP) and Diamondback Energy (NYSE: FANG) took advantage of their expensive equity currency to expand their existing positions in the Permian Basin via asset acquisitions.
EOG Resources (NYSE: EOG), PDC Energy (NSDQ: PDCE), SM Energy (NYSE: SM), and other producers on the outside looking in also announced big asset acquisitions in the Permian Basin. In contrast, Oasis Petroleum went in the opposite direction, purchasing 55,000 net acres in the Bakken Shale from SM Energy for $765 million.
Oasis Petroleum’s decision to diversify into the Permian Basin is far from unique; however, the timing and abruptness of this strategic shift inherently raise questions about the quality of the company’s so-called extended core in the Bakken Shale and magnifies concerns about the rising gas-to-oil ratio in the Wild Basin.
That said, adding a 20,000-net acre position in the Delaware Basin doesn’t shift the company’s production and revenue mix appreciably from the Bakken Shale, where the company owns about 500,000 acres and still plans to run five drilling rigs in 2018.
Perhaps that’s one of the market’s concerns about the transaction: Oasis Petroleum’s own experience in the Bakken Shale demonstrates the importance of scale to keeping costs in check and maximizing returns. Aside from the opportunity to recycle capital by dropping down midstream assets to Oasis Midstream Partners, one wonders what kind of value the company can create from 20,000 acres.
Wisely, Oasis Petroleum will take its time appraising its newest property, running one rig in the Delaware Basin through the first six months of 2018 and possibly adding another drilling team in the back half of the year. Management’s guidance calls for the exploration and production company to grow its output to 88,000 barrels of oil equivalent per day, about 5.7 percent of which will come from its new assets in West Texas.
But pursuing a surprise transaction that sows doubt about the company’s existing asset base was never going to be good for investor sentiment, especially when the prevailing narrative focused on Oasis Petroleum as a likely consolidator in the Bakken Shale. The question is whether these investors want to stick around while Oasis Petroleum expands its presence in the Permian Basin. The market’s reaction to the deal suggests that investors wonder why they should own a latecomer to the Delaware Basin when their portfolios likely include pure plays and early entrants that have much lower return hurdles.
More important, this move also gives credence to lingering concerns about the Bakken Shale’s ability to compete against the economics of the Permian Basin and other stacked plays. This point is underscored by the Bakken Shale’s progressively diminished prominence in EOG Resources’ slide decks, Continental Resources’ (NYSE: CLR) big push in the Midcontinent SCOOP and STACK plays, and QEP Resources’ (NYSE: QEP) big acquisition in the Midland Basin.
What explains the seeming urgency to add exposure to the Permian Basin?
The reservoir rocks include exposure to multiple oil-bearing formations, enabling producers to extract hydrocarbons from the same infrastructure—potentially a major source of cost savings and a huge competitive advantage.
For example, during Occidental Petroleum Corp’s (NYSE: OXY) first-quarter earnings call, the company’s president of domestic oil and gas asserted that the company would realize a more than $10 per barrel reduction in its break-even costs on wells targeting secondary benches at its Greater Sand Dunes play in New Mexico.
At the Energy Information Administration’s annual energy conference, Scott Sheffield, CEO of Pioneer Natural Resources (NYSE: PXD), asserted that break-even costs in the Delaware Basin could be as low as $25 per barrel.
These opportunities help to explain the frenzy for exploration and production companies to add exposure to the Delaware Basin, an area where blocky acreage packages conducive to drilling longer laterals are easier to come by than in the Midland Basin.
This Permania has extended to the midstream segment, where Plains All-American Pipeline LP (NYSE: PAA) and NuStar Energy LP (NYSE: NS) earlier this year purchased expensive gathering systems in the Permian Basin.
Given the equity issued to fund these transactions and the elevated yields at which these stocks traded, these deals exacerbated the near-term risks to both master limited partnerships’ (MLP) distributions. These desperate moves underscore the potential for the Delaware and Midland Basins to take market share in an environment where oil prices remain lower for longer.
Although we question the need and timing of Oasis Petroleum’s initial foray into the Permian Basin, the selloff in the stock appears overdone when you consider our 2018 outlook for oil prices–articulated in this free video–and the improvement in the company’s balance sheet.
From a bigger-picture standpoint, the market’s negative reaction to Oasis Petroleum’s acquisition gives credence to the narrative that investors have grown increasingly concerned about capital allocation in the US onshore space and that exposure to the Permian Basin isn’t a cure-all for sentiment.
A Precursor of Upstream Takeovers to Come?
Noble Midstream Partners LP’s (NYSE: NBLX) stock gave up about 8.5 percent of its value on Wednesday morning.
The proximate cause of the selloff: The MLP announced the pricing of $3.2 million common unit to help fund the $625 million purchase of Saddle Butte Rockies Pipeline as part of a joint venture with privately held Greenfield Midstream. Noble Midstream Partners will own a 54 percent interest in the joint venture, dubbed Black Diamond Gathering.
The Saddle Butte Rockies Pipeline comprises a large-scale oil-gathering system that serves about six customers in the Denver-Julesburg Basin–an area where Noble Midstream Partners’ sponsor, Noble Energy (NYSE: NBL)–has a formidable presence. With a 96,000-acre dedication to the Saddle Butte Rockies Pipeline, PDC Energy (NSDQ: PDCE) is the system’s anchor shipper.
One wonders if Noble Midstream Partners’ joint venture to acquire the Saddle Butte Rockies Pipeline could signal Noble Energy’s interest in eventually acquiring PDC Energy.
Noble Energy has demonstrated a willingness to pursue takeovers of companies that management perceives as offering underappreciated value, scooping up Rosetta Resources and Clayton Williams Energy at 25 percent premiums to build a low-cost position in the Delaware Basin. This strategy stands out in a period when asset sales and acquisitions of private companies have predominated.
PDC Energy falls into the value category, and its assets in the Niobrara Shale and Delaware Basin would increase Noble Energy’s scale in these areas. At the same time, PDC Energy also owns midstream infrastructure in the Delaware Basin; dropping this infrastructure down to Noble Midstream Partners would help to alleviate the financial burden associated with the deal.
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Elliott and Roger on Feb. 27, 2020
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