US shale firms are teaming up with Wall Street to frustrate OPEC

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US shale producers survived an oil price crash and confounded
OPEC’s efforts to drain a global glut by employing innovative
drilling and production techniques. Now, some of these producers
are turning to creative investments to pump more oil.

Drilling joint ventures, called “DrillCos” for short, combine
cash from investors like Carlyle Group LP with drillable-but-idle
land already owned by producers. Investors get a pledge of
double-digit returns within a few years, while producers can
raise productivity without spending more of their own money.

The total raised by these ventures – at least $2 billion in the
last 24 months – is a small part of overall shale financing. But
they represent another way for Wall Street and shale producers to
increase the flow of oil, and frustrate plans by the Organization
of the Petroleum Exporting Countries to prop up prices.

Private equity this year has showered more than $20 billion on US
energy ventures. Driven by shale expansion, US oil production
this year is forecast to increase by 570,000 barrels per day
(bpd) to 9.9 million bpd, the US Energy Information
Administration estimates.

NO BALANCE-SHEET RISK

Drillcos take control of drillable land and generally turn over
100 percent of the cash flow from oil and gas production to
investors until they earn a 15 percent return. At that point,
control reverts to the producer, with the investor’s stake
shrinking to about 10 percent of remaining production.

“It’s a type of surgical, temporary capital,” Mark Stoner a
partner at private equity fund Bayou City Energy LP, said in an
interview. Bayou City committed $256 million to an Oklahoma
drillco with privately held Alta Mesa Holdings LP
[ALMEH.UL] last year.

“We get exposure to great, prolific oil basins, but don’t have to
take on balance sheet risk.”

Companies such as EOG Resources Inc , one of the financially
strongest US shale producers, are turning to drillcos.

Two months ago, EOG struck a $400 million deal with Carlyle to
finance wells in Oklahoma. The investment lets EOG focus its own
cash on the Permian Basin, the largest US oilfield, and lifts its
production without increasing its spending.

The venture also allows EOG to double or triple the value of land
it held on its books, Lloyd Helms, EOG’s head of exploration and
production, said an industry conference in May.

Legacy Reserves LP , Exco Resources Inc , Alta Mesa and EOG are
among 34 oil producers that since 2015 have formed drillcos worth
more than $2.05 billion. The money has come from investors
including Blackstone Group , Carlyle, KKR & Co , and others,
according to 1Derrick Ltd, which tracks oilfield land deals.

PUTTING IDLE LAND TO USE

Historically, one way producers wrung more cash from financiers
was to pledge future output for cash payments to finance
drilling. There was no swap of land and no guaranteed return.
Drillcos differ in that investors get control of land until a
double-digit rate of return is met, providing insurance against a
default.

For producers, these ventures also help boost the total amount of
oil they can eventually recover. Wall Street is rewarding those
with strong production with share price gains at a time when OPEC
and its allies have agreed to pull 1.8 million bpd off the global
market.

“This helped us drill acreage that we wouldn’t otherwise have
been able to drill right away,” Mike McCabe, Alta Mesa’s chief
financial officer, said in an interview.

For investors, the potentially high rates of return, compared
with commercial loan rates running about 5 percent to 7 percent,
have spurred interest despite crude prices under $50 a barrel.

“There’s a lot of money seeking a home, especially in this low
interest rate environment,” Mingda Zhao of Vinson & Elkins
LLP, a law firm that has negotiated drillco agreements, said in
an interview.

Drillcos are not risk free. If oil prices tumble, investors’
ability to grab high returns within a few years fades. Shale
producers also must be willing to provide more information on the
land than they would under more common loan agreements.

Such detailed information “gives us well-level insight into
what’s going on in a basin,” said Bayou City’s Stoner.

For Carlyle, one of the world’s largest private equity funds, the
drillco with EOG was a relatively low-risk way to invest in US
shale.

“We were looking for very specific types of assets and drilling
deals to make the risk-return work for us,” David Albert, co-head
of Carlyle’s Energy Mezzanine Opportunities funds, said in an
interview.

The funds, with more than $4 billion under management, can still
make money on its drillco investment even after oil prices
slipped below $45 per barrel this month on oversupply concerns.

“Even with current oil prices, there are still economic
opportunities to be had out there,” Albert said.

Read the original article on Reuters. Copyright
2017. Follow Reuters on Twitter.

Read the original article on Reuters. Copyright 2017. Follow Reuters on Twitter.