The Allure of the Deep: A Big Bet on Gulf Oil
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By now, most everyone is aware of British Petroleum’s (NYSE: BP) sale of a portion of its Gulf of Mexico Deepwater assets to Plains Exploration and Production (NYSE: PXP). Not long ago, Gulf properties were looking less than exclusive. The Deepwater Horizon accident and the resulting moratorium led some companies to shy away from the Gulf as activity slowed down. Plains itself was one that walked away, selling its GOM gas assets to McMoRan for a combination of cash and MMR equity. Even before the accident, Devon Energy (NYSE: DVN) quit the Gulf to concentrate on its onshore assets. TOTAL also divested GOM assets to W&T Offshore pre-Macondo. The economic slowdown had already begun to have an effect. With drilling grinding to a halt, this previously trendy address was looking a little run down. However, this deal carries a Park Avenue premium that suggests that interest in the Gulf has been rekindled.
Plains acquired BP’s interest in three deepwater fields: Holstein in south-central Green Canyon, and Marlin and Horn Mountain on opposite sides of the Viosca Knoll and Mississippi Canyon border. The deal nets Plains 67,000 barrels of oil equivalent (BOE) per day of production and 127 MMBOE (million barrels of oil equivalent) of proved reserves. The $6.1B deal appears to be one of BP’s better deals as it zeros in on its monetization goals. Any way you slice it, the price Plains paid is pretty steep. As with any asset there are number of ways to appraise value. Consider the price relative to reserves. A “proved” barrel is one that can be extracted with 90% certainty at current costs with current technology. This is the low hanging fruit that’s easy to reach. Think of it as inventory. The pricing of GOM acquisitions from 2006 to the present is shown in Figure 1. Since 2006, the average paid per proved BOE in GOM acquisitions is $22.02. Based on the reserves reported for this deal, Plains’ cost is $48.00 per BOE, over twice the GOM average for the time frame. In fact, only one deal priced anywhere close to this acquisition.
For another perspective, consider looking to the market for comps. Energy XXI (NASDAQ: EXXI) and Stone Energy (NYSE: SGY) are both decent comps based on reserve size and production. Again, there’s a clear premium that’s been paid in this transaction relative to the market’s pricing of the smaller independents (see the Table below Fig 1 for EV and reserve details). Plains could have bought any number of GOM independents at a better price. There’s no doubt that Plains paid handsomely for these fields on a reserve basis.
In contrast, the production is substantial and it’s much easier to justify the purchase that way. The $91,000 per flowing barrel that Plains paid compares more favorably to current market valuations, especially for oily producers like Energy XXI (see Table above). The large amount of production in place is also a key piece of the equation for Plains. It allows them to forego immediate development and use the cash flow from the fields themselves, to pay down the debt used for financing. Once they get back to investment grade metrics, they plan more extensive development. From management’s perspective, these are assets that will pay for themselves with little short term capex. Guidance is for a two year period of time to perfect development and exploration plans, while paying down financing debt.
The price that Plains was willing to pay shows you the allure of the Deepwater. The Deepwater is the playpen of the rich and famous. To play you must pay, and the impact of the Deepwater is hard to dismiss. Reserves out there are larger and production rates are much, much larger. Single wells can produce at rates well over 10 times the level common on the GOM shelf. A chart of GOM production is shown in Figure 2. Even a cursory scan makes it obvious that all of the top producers are in the Deepwater. These are very lucrative assets.
And that’s really the point. This deal is about potential, not just reserves or current production. Most of the deals shown in Figure 1 involve mature assets with less potential for upside beyond their proved reserves. That upside potential is illustrated by Holstein. The field currently produces just a sliver of the platform’s capacity. There’s room to grow production almost 10 times before they max Holstein out. Thirteen development wells have already been identified to increase production from shallow Pliocene zones. Deeper strata known to be productive in Green Canyon (Miocene and Lower Tertiary) are completely unexplored. In addition to this ‘on-lease’ potential from their own blocks, the location of Holstein has potential to bring in third-party production. In the Deepwater, with its huge infrastructure costs, tie-backs to neighboring production platforms are often the only way to make production of smaller finds economical. The platform is well positioned in southern Green Canyon to serve as a production hub for some adjoining smaller third-party finds that are likely uneconomic without a third-party production agreement. None of this additional resource potential appears in reserve reports. It’s this potential upside that induced Plains to pay up for these fields.
The deal is also part of a concerted effort to get oilier and dispense with fringe nat gas assets. That’s consistent with Plains’ divestiture of its GOM shelf assets to McMoRan in 2010, and their more recent sale of onshore Granite Wash acreage to Linn Energy. Both asset sets are principally gas. They anticipate much greater return on investment from the new offshore assets in their portfolio. To pay for part of the acquisition, Plains intends to dispose of additional onshore gas assets in the future for anticipated proceeds of $1.5B to $2B. The remainder of the BP acquisition will be funded through debt.
Overall, this would seem like a big plunge for a producer with no Gulf of Mexico operations, but that’s deceptive. Plains Exploration CEO Jim Flores served as CEO of Ocean Energy from 1995 to 1999, and then as Chairman after its merger with Seagull Energy. Ocean built a high profile portfolio of Deepwater prospects internationally before its acquisition by Devon in 2003. They also operate offshore platforms in California. So, Plains actually has a great deal of offshore experience to draw on. This isn’t really a move to the Gulf for these guys. It’s a move back to the Gulf. They certainly have the experience to get the most from these interesting assets. That experience will be critical, because Plains paid a pretty penny for this acquisition. Two things bear watching. They need to keep production up to pay off that acquisition debt. Marlin currently supplies most of that production. Investors need to keep an eye on its decline. The other is Holstein. Management was especially excited about Holstein, admitting that they’ve coveted the property for years. They’ll need some significant exploration upside there to justify the price of this deal.
Plains recently held an analysts meeting to explain the deal to the Street. While the presentation is three hours long, the meeting begins with a more bite-sized 32 minute overview of the deal that touches on the important details.
JustMee01 has a position in EXXI. The Motley Fool owns shares of Devon Energy. Motley Fool newsletter services recommend Total SA. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.