NON-OPERATED OIL & GAS INTERESTS:
BUILDING & FINANCING A PORTFOLIO
JAY G O L D FA R B, P H . D.
W O O D B R I D G E O I L & G A S A DV I S O R S
M AY 2 2 , 2 0 1 2
Agenda & Presenter
INTRODUCTION
AGENDA:
1.
2.
3.
4.
5.
Introduction
Capital Sources
Illustrative Economics
Summary/Conclusions
Contact
PRESENTER:
Jay Goldfarb, Ph.D. is President of Woodbridge Oil & Gas Advisors 1, an investment banking firm specializing in the sale of
upstream oil & gas properties. Jay has assisted his clients with the execution of more than $1 billion of acquisition,
divestiture and financing transactions throughout North America, including numerous Bakken projects. Prior to joining
Woodbridge, Jay was a Vice President at Mesirow Financial, a Chicago-based boutique investment banking firm. He holds a
Ph.D. in Chemical Engineering from the University of Massachusetts at Amherst.
1 Securities
offered through Woodbridge Financial Group, LLC. Member FINRA, SiPC
2
Single Well Economics – Participating vs. Selling Undeveloped Core Acreage
 Bakken development
activity is challenging the
non-operated working
interest owner’s ability to
finance participation
 Selling undeveloped core
acreage will capture only
a fraction of the potential
returns available from
participating
 The market for
undeveloped acreage
demands a seemingly
high rate of return
compared to risk
SINGLE BAKKEN WELL ASSUMPTIONS AND ECONOMICS
Gross EUR (Mboe)
585.5
Realized oil price ($/bo)
75.0
Realized gas price ($/mcf)
5.0
NRI (%)
80.0%
Completed well cost ($)
8,000,000
After Tax NPV-10 (assume 35% tax rate) ($)
7,228,666
ATAX IRR
46.5%
UNDEVELOPED CORE ACREAGE FOR ONE WELL
Well spacing (acres)
320
Market value ($/acre)
5,000
Market value ($)
1,600,000
After Tax $ (assume 35% tax rate)
1,040,000
NOTE: The examples contained in this presentation are for illustrative purposes only . You should consult
with appropriate experts to evaluate specific investment opportunities.
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INTRODUCTION
Rates of return from drilling in core areas are too extraordinary to forego for lack of
funding
Opportunities and Challenges of Non-Op Oil & Gas Interests
Opportunity
• Extraordinary ( 40 to 100%+) rates of return available from participating in
drilling on the leases
• Upside potential from re-fracs, increased density and secondary targets,
particularly the deeper Three Forks benches
• In the core area, no geological risk; development risk is quantifiable
Financing is a challenge
• Up-front investment
• Limited production = limited borrowing capacity
• Rapid drill-out accelerated by pad drilling, walking rigs
Keys for Success
• Effective use of leverage – Match to assets, IRR, timing of cash flows
• Support decisions with engineering data and financial analysis
• Financial model, capitalization and exit plan
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INTRODUCTION
Non-operated interests are essentially financial assets. Managing these assets consists
of choosing the structure and timing for a series of financing and divestiture
transactions. Effective planning and decision analysis supported by financial modeling
is essential for maximizing value.
Elements of a Successful Plan
Investment Objectives
• Capital willing to risk
• Expected return
• Risk/Return proposition – growth and exit
• Define acceptable risk
Essential Plan Elements
• Development plan
• Cash flow forecast, external funding and contemplated progression of financings
• Return on equity
• Hedging/risk management – what is comfort level with oil prices and reserves
• Engineering and reserve report
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INTRODUCTION
The plan is the Roadmap for the transformation of a portfolio of undeveloped working
interests to cash. It provides support for decision analysis related to potential financing
and divestiture transactions.
Capital structure, Risk and Pricing
Risk Type
IRR Objective
Engineering Risk
5%
Exploration Risk
10%
20%
35%
50%+
Proved Producing
Proved Non-Producing
Proved Undeveloped
Probable Producing
Proved Undeveloped
Proved Undeveloped
Wildcat
Capital
Parameters
Senior Bank Debt Mezzanine /Sub Debt
~60% of PDP Small Development expected to cure
% PDNP/PUD
loan to conforming bank debt
within 12-18 months
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Equity
No proven reserves,
limited probable
reserves
CAPITAL SOURCES
Understanding the capital markets is essential for managing these assets. The market
provides a spectrum of products to suit the capital requirements and associated risk.
Economics of Mezzanine Financing for a Single Well
Illustrated for the first two years production, a typical mezzanine maturity
SINGLE WELL INCOME STATEMENT
Production (Mboe)
Revenue
Operating expenses
Production taxes
Depreciation and amortization
Mezzanine loan interest and fees
Income before tax
Taxes @ 35%
Net Income
Cash Flow Statement
Net income
Depreciation & amortization
Cash from operations
CAPEX
Mezzanine loan advance
Change in cash
FIRST TWO YEARS
($MM)
230
15.6
(0.2)
(1.7)
(5.1)
(3.0)
5.5
SINGLE BAKKEN WELL ASSUMPTIONS AND ECONOMICS
Gross EUR (Mboe)
585.5
Realized oil price ($/bo)
75.0
Realized gas price ($/mcf)
5.0
NRI (%)
80.0%
Completed well cost ($mm)
8.0
(1.9)
3.6
NET ASSET VALUE AT END OF YEAR TWO
PV-10
Cash from operations
Mezzanine debt
NAV
3.6
5.1
8.7
(8.0)
8.0
8.7
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($ millions)
6.9
8.7
(8.0)
7.7
ILLUSTRATIVE ECONOMICS
Mezzanine Lenders seek 18%+IRR with typical two year minimum term. The cost of
this capital should not be a barrier as the typical Bakken well pays out the loan by
maturity.
Initial Development Funded with Mezzanine, Refinanced with Senior Debt
UN-LEVERED CASH FLOW ($ 000's)
Net wells (EOY)
BTAX operating cash flow
TAX
CAPEX
Unlevered cash flow
YR1
YR2
10
YR3
20
30
40,159
95,168
-
(16,309)
(80,000)
(39,841)
Total
30
30
119,722
96,558
351,606
(22,903)
(27,795)
(67,007)
(80,000)
(80,000)
-
(240,000)
(1,141)
16,819
68,763
44,600
119,722
DRILLING FUNDED WITH MEZZANINE LOAN REFINANCED BY SENIOR DEBT AT END OF YR2
BTAX operating cash flow
40,159
95,168
Interest
(14,400)
(14,400)
Tax
(5,284)
CAPEX
(80,000)
(80,000)
Change in cash
(54,241)
(4,516)
Mezzanine debt draw (18% ROR)
80,000
Mezzanine debt paydown
(80,000)
Senior debt draw (6% ROR)
59,000
Senior Debt paydown
Net Debt
54,241
58,758
Cash
-
•
•
•
•
YR4
96,558
351,606
(4,130)
(3,150)
(36,080)
(21,457)
(26,693)
(53,434)
(80,000)
-
(240,000)
14,135
66,715
22,092
-
-
(80,000)
-
-
59,000
(14,000)
(45,000)
(59,000)
-
80,000
44,623
-
22,092
Mezzanine finances initial drill-out @ 18% ROR, minimum 2 yr. duration (1.4x return)
Refinanced with senior conforming loan, advance rate less than 60% of PDP PV-10, at end of year 2
Further drilling could be funded with senior debt and cash flow
Need for mezzanine is limited, cost of capital is a blend of mezzanine and senior rates
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ILLUSTRATIVE ECONOMICS
Mezzanine lenders may finance 100% of development expenses with no starting
production on the leases. Production generates borrowing base to refinance with less
expensive senior debt.
Summary Economics
CASH FLOWS ($000s)
UN-DISCOUNTED
After tax cash flow
PV-10
314,304
126,154
Interest
36,080
30,246
Tax savings - interest deduction
12,628
10,586
After tax interest expense
23,452
19,660
NET ASSET VALUE ($000s)
UNDEVELOPED
Undeveloped acreage @ $5000/acre
DRILLED-OUT YR4
48,000
-
Cash
-
22,092
PV-10 production
-
164,676
48,000
186,768
NAV
Change in Reserves
POTENTIAL UPSIDE
Refracs and increased density
Deeper Three Forks Benches
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Bo
50%
7,500,000
100%
15,000,000
ILLUSTRATIVE ECONOMICS
In this example, 100% of the external capital requirement is funded with debt,
resulting in significant value creation relative to the cost of capital. Upside is
retained.
Summary and Conclusions
 Mezzanine loans is an alternative to equity and may finance 100% of
development costs is proven areas with attractive economics.
 Mezzanine loans can be refinanced with less expensive senior, reserves based
lending. Reserves based lending and cash flow will be available to finance
subsequent development.
Hold or Sell?
 The market for undeveloped acreage appears to demand equity returns
inconsistent with risk, particularly when considering the potential upside.
 Notwithstanding the upside, buyers for production will accept lower returns,
limiting the attractiveness of holding. Further, the benefit of holding
production is offset by the tax arbitrage between ordinary income and capital
gains.
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SUMMARY/CONCLUSIONS
Summary
 Rates of return from drilling in core areas are too extraordinary to forego for
lack of funding.
CONTACT
Upstream oil & gas asset acquisitions and divestitures
CONTACT:
J AY G O L D FA R B , P H . D .
WOODBRIDGE OIL & GAS ADVISORS
847.668.8472
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