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"We're executing the strategy that we've articulated, and we're excited to add this asset to our portfolio." These were the first words out of QEP Resources (NYSE:QEP) CEO Chuck Stanley's mouth when I asked him about the company's recent expansion of its footprint in the Permian Basin of West Texas.
One never knows how the market is going to react to major acquisitions or divestitures in the oil and gas industry. With so many variables in play at any given time, and psychology playing at least as big a role as raw numbers, the market's response to any big transaction can be almost impossible to predict.
Nowhere has this phenomenon been more true than in the highly productive Permian Basin which straddles the border between Texas and New Mexico. A year ago, acquisition and divestiture activity in the Permian was proceeding at an explosive pace. It was easily the most active area for such activity in the oil and gas industry worldwide.
During July and August of last year, a time when the WTI price for crude oil was moving between $39 to $45 per barrel, company after company was acquiring acreage in the Permian region at prices ranging from $40,000 to as high as $60,000 per acre. While a few of these transactions were panned by the market, others were very well-received. Although QEP's stock has trade down its own transaction was announced, Stanley and his management team expect their recent deal will ultimately be viewed positively as well, since it makes so much sense within their corporate strategic plan.
"We're not getting caught up in the market's immediate reaction," Stanley said. "Obviously, timing is everything in the oil patch, but we can't choose the time when an opportunity like this presents itself, and we captured it when we could."
Part of the somewhat negative reaction by the market to QEP's deal is a perception that the company may have overpaid for the assets on a simple per-acre cost calculation, at a time when the price for crude had fallen back into the $48/bbl range. That may make sense to some market analysts, but the reasoning seems a bit off when one considers that QEP's simple per-acre cost was in the same range as those transactions from last summer, and oil price was actually a bit higher than it was during July and August 2016.
In its investor presentation on the acquisition, QEP estimates the new acreage contains 730 drilling locations over four de-risked horizons. I asked Stanley to expand on that.
"So, the deeper horizons are the Wolfcamp A and B, the Spraberry Shale and the Middle Spraberry. We are actively developing all four formations on what we call our Mustangs Springs block, and part of this new acreage is contiguous with that leasehold. We also acquired another big block that is just east of Sale Ranch, one of the most prolific multiple-horizon blocks in the Basin."
"I should emphasize that, within those four target horizons are what geologists call 'landing zones' or 'benches' (hydrocarbon producing layers within each formation). For example, we have multiple 'benches' within both Wolfcamps and multiple 'benches' within the Spraberry that we're targeting. That's a subtlety, but it's important, because in those 730 drilling locations we talk about, we're including multiple 'benches' within some horizons."
All of which helps to explain why Stanley objects to measuring this acquisition in terms of a simple dollars-per-acre calcuation.
"Simple acreage math is misleading," Stanley says. "It actually works out to about $12,800 per net mineral acre horizon on a de-risked basis, which compares favorably to other deals in the basin, and that's the math we like to use," because he considers it to be a better gauge of the true cost of the acquisition. "I just think that's a better number, because in some parts of the Basin there are multiple targets and in some parts there are single targets."
"[The acquistion] is part of our long-term strategy to transition to a more balanced portfolio of crude oil properties, and it moves us substantially along the way to almost a 50/50 balance (between oil and natural gas) in our reserves and production on a pro-forma basis."
"We pivoted out of Pinedale, which was a mature natural gas asset, and we're redeploying the proceeds into a highly-prolific crude oil growth asset." All of which makes sense within the context of the company's strategic planning.
Moving on from acquisition cost-related issues, I asked Stanley to offer his thoughts on existing pipeline capacity constraints coming out of the Permian for both oil and natural gas. I wondered if this had given him any heartburn about taking on an expanded footprint in the Basin.
"We've seen the midstream industry respond to capacity constraints in other basins in the past with great success. There can be temporary dislocation in pricing and basis differentials, but that sends a strong signal to midstream companies to build additional capacity." Plus, he pointed out, producers are able to manage this sort of exposure in a variety of ways.
"So, we don't really worry about that." He pauses. "Plus, there's a few good things about the Permian Basin: #1 it's in Texas, #2 it's in Texas, #3 it's in Texas." He chuckles before going on. "You don't have big weather issues, you don't have to cross big mountain ranges that can lead to long permitting delays. It's a pretty hospitable regulatory environment that allows you to get things done. So the pipeline developers are not facing the kinds of obstacles they are facing in other parts of the country."
QEP Resources well understands the advantages of producing in Texas, given its years as a Texas producer, and the company's long-standing status as an active producer in the Inter-mountain West, where heavily regulated federal lands are the most common land type. Given that, and given that the new acreage position is such a strong fit for the company's go-forward plan, it's easy to see why Stanley is so upbeat about the transaction, even if the initial market reaction wasn't what he had hoped for.
The timing of the transaction may have seemed problematic to some in the investor community, but it couldn't have been better from Chuck Stanley's point of view.
