The cash divide

In early October, Devon Energy Corp. president John Richels stood up before investors at an oil and gas symposium in San Francisco and told them the bitter truth: that the credit squeeze would force many midsized players in the oil and gas industry that have great prospects but are short of cash to merge to fund their operations.

"In the past, you could always sort of squeeze up to the top of the line and know that you could go out another line tomorrow if you need it. I don't think that's the case anymore," he said. "The likelihood of consolidation is going to be higher in the next few years than it has been."

Get ready for the battle of the haves and the have-nots. With the credit crunch, ensuing financial crisis and severe drop in commodity prices, it's becoming clear which companies in the oil industry have cash to fund their development and acquisitions, and which ones don't.

"When we closed the second quarter, we had robust commodity prices, readily available credit, an equity market that was open, rig availability, a growth restraint and stocks at all-time highs. It's transformed into, 'Brother, can you spare a dime?'" says Tom Petrie, a longtime oil watcher and investment banker at Merrill Lynch & Co. "We've gotten back into a zone of rationality for possible transactions on the corporate side."

Over the past few months, the news has been littered with companies looking to do joint ventures and asset sales to keep their operations humming. Chesapeake Energy Corp. was among the first of the lot, announcing in August it agreed to sell 90,000 acres of natural gas properties in Oklahoma's Arkoma Basin Woodford Shale area to British oil giant BP plc for $1.75 billion in cash. The next month, it agreed to sell one-quarter of a natural gas-producing venture in Arkansas' Fayetteville Shale, also to BP, for $1.9 billion. It then agreed on Nov. 11 to sell a 32.5% interest in its Marcellus Shale assets in Appalachia to Norwegian natural gas giant StatoilHydro ASA for $3.38 billion.

Most recently, Delta Petroleum Corp. said it hired Merrill Lynch and J.P. Morgan to advise it on joint-venture alternatives or the sale of parts of its interest in the Piceance Basin in Colorado, where it believes it has 2.5 trillion cubic feet equivalent of recoverable natural gas reserves. "Our exploration of options and alternatives for our Piceance assets is a reaction to the market's failure to reasonably value these properties," Delta CEO Roger Parker said in a statement.

Finding JV partners and coming up with an agreeable price haven't been easy, however. Dallas oil and gas explorer Exco Resources Inc., for instance, said Nov. 6 it is no longer looking for a JV partner for its East Texas-North Louisiana and Appalachia operating areas because of market conditions. It had hired Goldman, Sachs & Co. in July to advise it. It is evaluating the sale of noncore assets and is selling some of its East Texas assets.

"There are a lot of packages out there right now, but the problem with the industry is how do you price it," says John Schaeffer, managing director and head of the oil and gas unit at GE Energy Financial Services, which recently signed a partnership with TriTex Energy LLC to buy up properties in southeastern New Mexico for cash. "Since September, it's been hard to know how much the banks will advance companies. There's a lot of equity that would like to buy the reserves, but there's no debt to leverage it. There are a lot of hung deals right now."

Michael Dillard, an attorney at Akin Gump Strauss Hauer & Feld LLP in Houston, says the situation is as bad as he's ever seen it for the oil and gas industry.

"I've never seen the combination of falling commodity prices, recession on a global basis and tight credit in my career," he says. "We're starting to see more and more companies in this industry that are having such significant issues that bankruptcy is a real possibility. Some will be able to manage through some of this, but some players who put all their eggs in one basket will not."

Some busted deals are emerging. Dallas explorer Denbury Resources Inc. announced Oct. 8 it decided not to pursue its Conroe Field acquisition in Texas from an unnamed party for $600 million because of market conditions, forfeiting its $30 million, nonrefundable deposit. The deal had been announced in August.

Development must continue in the sector, however, if oil and gas producers have any hope of meeting the world's growing energy needs, which the International Energy Agency recently estimated will reach 106 million barrels per day by 2030, versus 86 million barrels this year. The agency expects that $8.4 trillion in investments will be required to meet that need; prices by then could be $200 per barrel.

The companies that have the cash to do development-­related deals -- the global oil giants, the former seven sisters who have since combined beyond recognition -- are flush with $63 billion after benefiting from record high oil and gas prices earlier this year, according to Tudor, Pickering Holt & Co. Securities Inc. "The cash should not be burning a hole in anyone's pocket, but the disconnect between stock prices and [net asset values] is becoming staggering," the firm wrote in a recent report. "The credit crunch and market volatility is rattling and deciding on deal terms has to be a nightmare. So we'd be surprised if anything happens before year-end and surprised if something doesn't happen in 2009."

Petrie agrees. "The supermajors have been behind on focusing on resource plays, like shale and tight gas," he says. "Here's their opportunity to play catch-up or even leapfrog."

One continuing worry is that the credit crunch may also put the brakes on deals, as renegotiating credit lines for a transaction isn't easy these days. "But once the dominos start falling (like they have in past merger waves), they will keep falling," Tudor Pickering Holt wrote.

One supermajor chief executive, BP's Tony Hayward, says he is interested in picking up bargains in the oil and gas sector. "Some of them [smaller players] have been reinvesting more than 100% of their cash flow, and that's no longer possible," he said Oct. 28. "We have a good amount of firepower available, and it will increase."  Continued...