The bad old days of minerals and royalties buying was like navigating a massive and ugly spaghetti junction of benches, basins and plays. Where to buy and when—timing the drill bit was crucial—could make or break oil and gas mineral return on investments (ROIs).
As private equity shops entered the shale world’s minerals market, they have brought far more discipline, since returns in the PE world are prized above all else. And, by now, they have clearly found their bearings. Firms now buy undeveloped acreage that they know, given time, will turn into piles of cash.
NGP, for instance, has deployed more than $1.3 billion in the past decade in minerals as a standalone strategy. Post Oak Energy Capital looks for tangential opportunities alongside its upstream assets. Riverbend Energy Group likewise has amassed roughly 25,000 net mineral acres in the Lower 48 that will throw off cash this year.
Fund managers have learned to navigate the major thoroughfares that run through the Permian Basin, the Eagle Ford, the Bakken and other shale plays. A mix of technology, dedicated minerals teams and partnerships with upstream operators have streamlined evaluation of opportunities into an assembly line of sorts: data, rigorous evaluation and intelligence (or gossip from PE’s upstream allies).
The major challenge remains finding just the right off ramp, private equity executives said at the World Oilman’s Mineral & Royalty Conference earlier this year.
Scott Rice, managing partner and COO at Riverbed, said the firm’s minerals fund has built its position with more than 150 transactions, most of them knife fights, that will have cash flow “north of $100 million in the next 12 months.”
—Scott Rice, managing partner and COO, Riverbed Energy Group (Source: Riverbed Energy Group)
The buying is difficult. But the bigger concern, Rice said, is that the “food chain” for making an exit needs to evolve.
Selling to his peers at NGP, Post Oak or another private equity shop is all good and well, but those deals won’t generate the optimal return the fund wants, he said.
“We’re looking for that food chain—those big guys that continue to get big in the public market,” he said.
Since the early days of oil and gas mineral and royalty stockpiling, buyers have become more sophisticated and prodigious in their approach to the space.
Henry May, director at Post Oak, said he sees a continuation of the trend in the “professionalization of mineral ownership” that has occurred, more or less, in the past 10 years.
May anticipates more specialized pools of capital from family offices or dedicated mineral funds popping. And the asset class, in general, is starting to be better understood by the institutional investor community.
Matt Tramonte, vice president at NGP, said the more institutional capital is attracted, the more it will help bolster public markets.
“We’re still woefully underpenetrated in terms of institutional or public ownership of minerals, just across the board,” he said. “I think we’re all doing our damndest to break the mantra of grandaddy saying, ‘never sell your minerals.’”
May said that more bespoke investment vehicles will come. But he also remains puzzled by the disconnect between the clear value in low-risk mineral and royalty assets and the way in which Wall Street views them.
“It is continually surprising to me that the public market for minerals isn’t bigger than it is,” May said. “I mean, it’s much bigger than it used to be. But it’s still just a tiny fraction of what I think it should be.”
As a function of the debt and yield vehicles available to investors, “it’s really an ideal asset class.”
“My hope is that [the] public market, and [the] ultimate exit opportunity, also grows as well,” he said.
For now, everything Post Oak looks at is for life of investment.
“We don’t assume that we can exit in a few years when we look at minerals.”
How PE picks its spots
The barriers to buying into the minerals asset class aren’t terribly complicated. Anyone with a computer and an internet connection can log onto a mineral buying platform.
Private equity firms acknowledge that buying oil and gas minerals and royalties assets isn’t necessarily rocket science. Unsurprisingly, NGP and its kindred have nevertheless made it their business to fuel their funds with rocket fuel and overload their teams with science.
Tramonte said different strategies have emerged. Some buyers rely on marketing processes, others on ground games. Some are geographic, others basin agnostic.
“Yes, anyone can get in and do it,” Tramonte said. “There’s lots of data available. You take a type curve, take a price deck, take an assumption on timing and, boom, you’re ready to go.”
Naturally, NGP’s process is vastly more rigorous and precise.
Tramonte said NGP has developed minerals companies—Mesa Partners II, Elk Range Royalties, Foundation Minerals II, Wing Resources—that each have dedicated strategies.
Tramonte said each is staffed with highly technical engineers and finance professionals that have specialized focus areas. Mesa, for instance, has longstanding relationships with operators in the Haynesville Shale. Foundation is “Midland [Basin] born and raised.” Wing is laser-focused on the Delaware Basin. Elk Range screens deals rapidly, sticking to a process and framework from which it seldom deviates.
NGP also is one of the most active sponsors in the U.S. of rig activity, so it can rely on what it knows—or previously owned—to inform its mineral buying decisions.
May said Post Oak evaluates deals ranging from $80,000 to $30 million. But he allows that Post Oak sees its process as more “artisan” and focused on each individual prospect.
In one transaction, some developmental acreage in the Delaware Basin has been mired in litigation, with the operator and mineral operator at loggerheads over how to develop the asset.
“We were able to get in and actually acquire that because we had a portfolio company that had a real positive geologic perspective on that acreage.”
Post Oak bought some of the undeveloped acreage, made some trades for longer laterals, then brought to bear other levers, including its service and water midstream entities, to work in conjunction to develop the asset.
“Sometimes it’s a whole lot simpler and sometimes it’s even more complex,” May said.
Adding to the complexity is the sheer volume of deals Post Oak evaluates either through its ground game or macerated deals.
“There’s just a high degree of deal flow and you’ve got to keep at it—you know, those repetitions, to know when something is attractive enough for you to lean in and … when you get kind of [to] the end of the stage and when you need to just kind of back things off and let things go.”
Riverbend’s approach to deals is distinct, since the firm is its own dedicated minerals team.
Rice said Riverbend relies on partners for input, including other private equity firms such as EnCap, Blackstone and Kayne Anderson.
But Riverbend’s analytic deal engine is seemingly based on inherent skepticism. As a deal comes in, it flows to engineering technicians, pre-evaluation, evaluation and then a deal time.
“All the time, we’re trying to kill the deal,” Rice said.
Riverbend uses basinal models and a dedicated team to update permits and activity, which constantly feed an engineering model that’s indifferent to what Riverbend’s acquisition side is involved with.
“So, we’re very focused on the process,” Rice said. “What can be measured can be improved. Every process, every point in the process, how can it get better?
“That’s how Riverbend’s been able to consistently deliver outsized returns, is because [of] our approach to the process.”
Rice said the company is always in pursuit of what he called the firm’s “True North.”
White space buyers
Private equity firms have one other ace up their sleeve. They’re not necessarily looking for the next development to be ready-made.
Rice sees an advantage to buying “white space” where acreage doesn’t necessarily come with a DUC or even a drilling permit in place. That approach is largely different from upstream A&D, in which PDP, DUCs and a firm sense of inventory are essential to the valuation of a deal.
Buying in, say, Midland County, with three DUCs in place and multiple permits seems almost too easy. The question, however, is how to find it.
“We’re all looking for it, and you kind of got to turn every chair over to get that one acre,” he said.
Riverbend’s process-oriented buying strategy works one mineral acre at a time, with the ability to anticipate that, at some point, which acreage is likely to be developed even without the paperwork and permits in place.
May said Post Oak is also keenly interested in white space areas that are undeveloped for now.
—Henry May, director, Post Oak Energy Capital (Source: Post Oak Energy Capital)
“In the mineral space, when you look at the actual value of that undeveloped inventory [it] ends up being a lot higher as a percent of the total deal value than when we look at our upstream investments,” he said. “We’re actually looking at very similar upstream investments from where it is in the development cycle.”
Tramonte said NGP also acquires white space acreage, which its operated portfolio companies consistently net up the interest “because there is that information asymmetry from an operated development schedule perspective.”
“But, again, that’s just being opportunistic,” he said. “So, we kind of play across the board within our main fund and the royalty partners fund.
“Like Henry [May] said, we’re going to lean on that undeveloped value more and be able to have a relatively long timeframe by which to invest and see that acre go from white space to permit to DUC to being developed.”
May said the vast majority of what Post Oak evaluates from a minerals perspective has “well north of 50% undeveloped value on it.”
The ultimate goal is to find an opportunity that’s perhaps 20% developed and buy it.
“And we want to see it developed 30%, 40%, 50% and then try to find that exit market,” he said. Then Post Oak, like other private equity firms, heads to that still half-built off-ramp that funds keep waiting to open a little wider.