As I complete my 34th year in the E&P business, I often reflect on my good fortune at having had an exciting, rewarding career. Although it seems to have happened gradually, the business looks nothing like what it did 34 years ago, when I started with Amoco in New Orleans as a junior geologist. In the grand scheme of things, the E&P business has not changed on the outside, but its structure, and how it functions in today’s world, have changed significantly. The business I started in looks fundamentally nothing like the business I work in today.
I say that for three main reasons. One, although the OPEC countries were a major force in 1980s oil markets, they were mostly provincial, focused almost exclusively on exploring and producing in their own territories. Today’s national oil companies (NOCs) can be major competitive forces outside their home countries in the upstream sector, and in mergers and acquisitions (M&A’s).
Two, the rise of international independents as exploration powerhouses is largely a phenomenon of the past 15 years. Prior to 2000, only a few independents had grown to the scale where they could compete with, and challenge, major and super-major international oil companies (IOCs) for exploration projects in their own backyards. During this same period, IOCs have de-emphasized global frontier exploration, with a few notable exceptions (deepwater U.S. GOM Paleogene, Arctic Circle, Brazil and Angola subsalt). While their participation in major exploration plays has declined, the IOCs will still take on material projects on a global basis, when the risks and rewards are acceptable. However, in a once-exclusive IOC playground, independents and NOCs now elbow each other for good opportunities.
Three, private equity (PE) financing has become a major force powering E&P activity in many countries. In North America, it was predominantly PE financing that funded independents willing to tackle shale plays. The IOCs and NOCs were primarily out of these plays until the independents proved they could work on a commercial basis. Now, both have entered the unconventional E&P space, primarily through acquisition of some of the larger independents. PE funding also has revolutionized the conventional E&P business, having led to the founding and growth of successful exploration companies like Tullow, Kosmos and Cobalt.
The PE portion of this transformation is still evolving, and the growth of PE investment in all aspects of the E&P business (including midstream) is surprisingly robust, even with challenged commodity prices. Whether there are upswings or downturns in prices, PE will find a way to capture the arbitrage in the business. In this regard, we see PE-funded companies springing up like mushrooms, formed to take advantage of overlooked or non-core, conventional E&P assets in the onshore U.S., Gulf of Mexico and shallow shelf waters; the upcoming licensing round (“Round 1”) in Mexico; the ongoing IOC divestments in Nigeria and other countries; and high-risk exploration offshore West Africa and many other areas.
The niche filled by these new companies not only benefits the industry as a whole, but I would argue it is critical to its future health and well-being. My argument is supported, and borne out, by recent history. For example, companies initially funded by PE revitalized exploration in West Africa and Colombia, two areas essentially abandoned by the IOCs as not material or too high-risk. Kosmos and Tullow, two early recipients of PE funding, started a feeding frenzy for acreage along the West African equatorial margin, following their discovery (with Anadarko) of the Jubilee field complex in Ghana. Gran Tierra Energy, Parex and others refocused the industry on Colombia, and now IOCs like Shell, Exxon Mobil and ConocoPhillips have re-entered the country after exiting during the 1990s-2000s.
The willingness of PE-based companies to accept the higher risks inherent in these and other areas reflects their need to generate higher rates-of-return on the capital they employ. Success has provided a positive feedback loop that has fostered additional risk capital and more PE-funded start-ups. The life cycle of such companies is as precarious as the risks are high. Many firms that start this way don’t always end up as successful as the examples mentioned previously. For every success, there are at least 10 failures, but PE remains undaunted.
The future of the oil markets remains unclear, due to weak commodity prices and a market cycle that is out of phase with the larger background supply-demand signal. Assuming that fundamental market dynamics re-emerge as a driving force in the E&P business within the next five years, PE-funded companies will likely play an even greater role in determining what that business looks like. The IOC’s will continue to divest non-core and late-life assets that smaller PE firms will scoop up and exploit, maintaining the flow of oil and gas from these otherwise neglected properties.
PE-funded exploration companies will continue to tackle high-risk plays in some countries that the industry believes have low or no potential, and surprises will certainly occur. And PE-funded companies will continue searching the globe for unconventional plays that the IOCs don’t wish to pursue, at least until they have been de-risked.
I see a bright future for private equity in the E&P business, especially as a driver for innovation, risk-taking and overall competitiveness. PE will continue to seek out talented management teams with demonstrated abilities to execute and deliver. In this way I think that the “well” of progress and advancement in the E&P business will not run dry anytime soon.