The Outlook for Land

As recently as 2018 a lease price of $95,000 per acre for a tract on the New Mexico side of the Permian Basin was setting records. Prices of $40,000 were not unheard of.

How quickly things change! The dawn of 2019 saw the end of investors’ spend-and-grow mantra, and the birth of make-money-now thinking. Leasing, while not at an end, has certainly seen a loss of momentum.

“A lot of operators are definitely scaling back even though there’s probably land work that could be done. They’re just trying to go bare bones from a land perspective in order to try to meet some of the demands from those banks and shareholders,” said Cole Frederick, who co-founded Midland-based Peak Land Services with business partner Mitchell Eberenz in 2014.

Whereas in the peak times mineral owners could hold out for the best deal, control is now fully in the hands of the operators. “Operators are starting to use regulatory tools to get around what used to give a landowner a little bit of leverage,” Frederick continued. “Now, Rule 37 exceptions have become pretty prevalent. Operators really have leaned on regulatory methods to avoid having to pay exorbitant prices for leases to mineral owners.”

The Texas Railroad Commission Rule 37 exception allows producers to move ahead with drilling acreage they have leased the majority of even though they may not be able to locate or for other reasons lease a particular tract. This rule keeps mineral owners from holding out for higher prices after neighboring acreage has been leased. “Nowadays, the holdouts, thinking they’ll get paid more money if they’re the last person to lease, run the risk of missing out on lease bonuses and royalties, because Rule 37 allows producers to continue forward without them,” said Frederick.

In short, “The main thing is that they’re not taking just any lease willy-nilly any more. It’s much more targeted and it has to make sense for a well that’s getting drilled in the very near future,” Eberenz said.

He added that many mineral owners have not tracked changes in the marketplace, still expecting the high rates common in 2018.

They noted that most of the hot areas—the Delaware and Midland basins and others—are still active, just not with their previous frenzy. “Historically, you had some land groups that would go out and take leases,” said Eberenz, and while that’s still happening some, “operators are a lot pickier as to what they’re going to buy up.”

The reasons all involve money, Frederick pointed out. “This activity [or lack thereof] relates to money from private equity groups, or just operators holding back funds. A lot of the activity is just drilling to maintain leaseholds, and not let leases lapse or expire.”

In this economy, most producers would rather drill up leases they’ve already paid for than to buy more.

What more is there to lease?

As the Permian Basin turns 100 this year, one might ask if all the good minerals haven’t already been leased, especially as the region has heated up with the advent of fracturing over the last 10 years.

Said Frederick, “Anybody who thinks that they’re going to come out to the Permian now and lease up a bunch of acreage and be able to drill it, they’re pretty late to the party—I don’t think that’s going to work out.”

However, “There are second-tier zones that people could go after—what everyone calls ‘fringe acreage’—but you’ve got to shake the edges of the Delaware or the edges of the Midland Basin, or the northern part of the Midland Basin toward Dawson or Borden counties.” He also listed eastern Howard County near the border of Mitchell County.

“That’s where the opportunities are,” but, he cautioned, “That’s the riskiest stuff.”

Land Technology

The availability of data online has made many oil and gas services more efficient, and the land sector is no different. Over the last three to four years Frederick and Eberenz have seen a major uptick in county land data availability online—and in its accuracy.

“It doesn’t totally eliminate trips to the courthouse,” said Frederick, “but it does save on mileage, time, and overall cost to the client by being able to do a lot of this stuff remotely.”

GIS is the second biggest technological benefit, said Eberenz. Data aggregators (like DrillingInfo, now known as Enverus) “have created some great products that have digitized a lot of Railroad Commission well data. It basically shortens the project’s life cycle from a land perspective.”

Encore Permian is an E&P with an in-house land department that uses a unique, proprietary asset identification software package, Mineral Scout, developed in 2017. J.D. Smith is the company’s co-founder and CEO.

J.D. Smith

They also have seen a sea change in equity markets. “Right now,” said Smith, “we definitely have a mandate to return capital” regarding their own PE obligations. “We’re probably done buying until we get a little more liquidity at this point.”

The buying frenzy of previous years did lead to overpricing of many assets, which made profitable deals harder to turn in those times, Smith said. Even with the drying up of those capital markets, there are still deals to be made for those who have some money.

“It’s a good buying opportunity if you do have capital.”

For Smith, as for Frederick and Eberenz, the most active areas are the Delaware and Midland basins. “They’re sort of the bell cows of the oil industry. There are so many good deals—a little bit of an extension on the plays,” he said, including one Encore is working near Rankin.

“There’s still new exploration being done,” he said, adding that Encore is also working south of Big Spring in a Wolfcamp B well. “That’s like brand new information and that looks to be a great economical well.”

The combination of a century of heavy production versus tight capital markets is spawning a lot of creativity. “The big companies, down to the smallest of private equity like us, they are getting really creative on being able to drill assets that they may not have the capital for,” Smith said. Decisions involve whether to drill, release, or farm out overbought acreage to another company.

Often a company will have bought a large tract in order to focus on the sweet spots within that acreage, understanding that other spots would be less profitable. With reduced budgets, it is no longer possible to drill out the less productive areas, but some activity is necessary to maintain the lease. Smith said this can lead to trades or sales of the less optimal land to someone who does have the budget to drill there.

Some of the creativity is in raising capital. “There’s a decent amount of capital out there if you don’t have to pay for the leasing,” Smith explained. Producers will “go in and drill wells and carry the people who own the leases—the farmers—and go ahead and start establishing production.” Sometimes this strategy involves drilling the maximum number of wells possible.

Reserve-based lending (RBL), a strategy wherein the loan is secured by proven reserves, is still popular, with more wrinkles. Smith sees a sliding scale, with everything from RBL on one side to outright purchase on the other, being in play, at all different cost levels for the financing, depending on creditworthiness and the nature of the reserves, existence of other production, and other factors.

Outlook for 2020

“I think we’re in the calm before the storm” regarding M&A activity due to tighter budgets, said Eberenz. “We’re getting calls from a lot of bankruptcy attorneys to help them put together inventories for filing against people not paying their bills. We normally don’t get that—we didn’t get that in the last bust.”

A large number of mergers, asset sales, and restructurings may be in the offing later in 2020, both believe.

On the positive side, Eberenz believes, activity will resume once all the above activity gets sorted out. The work that comes from new activity will be different, and that will greatly affect any newbies looking at entering the land business.

Smith as well believes early 2020 mergers and acquisitions are in “one of the deepest troughs ever.” He cited the Oxy-Anadarko purchase and Parsley’s acquisition of Jagged Peak Energy as the few significant transactions of 2019, but is confident things will pick up as 2020 develops. “I’m the eternal optimist, though, and I think it’s going to get better because I don’t think it can get too much slower as far as groups wanting more acreage or groups wanting to move up into the Permian,” he said, recalling 2014, when groups headquartered in Colorado and elsewhere felt they needed a Permian presence.

Of the future of landman work specifically, Frederick believes, “There’s not any easy, obvious lease plays where someone can just go out, run a tract of land that has one or two mineral owners, and lease them. A lot of our work’s going to be due diligence. All this acreage is HBP, held by production, so anything you want to find that’s open, you’ve got to sift through, and it’s going to take a talented land man who can do that.

“So I feel bad for young guys coming out of college trying to get in because there’s not a lot of that easy entry level work like there would’ve been maybe five years ago.”

Because the land business depends heavily on drilling and exploration activity, it’s often referred to as the canary in the coal mine for the oil and gas business—in a downturn, they’re among the first to feel the heat. While the current situation is not exactly a downturn, it is a cash-driven re-evaluation that still finds the land sector catching the first waves of the tsunami. The year 2020 may redefine this sector as much as any part of the oil and gas business.