The Permian Basin holds a lesson for the ages. What has happened here is a demonstration, to the world at large, of the best in free enterprise, capitalism, and human ingenuity.
by Jesse Mullins
[Editor’s Note: In this concluding installment of our three-part series, we examine the impact of Permian Basin growth within the Permian Basin itself, and in the wider world as well. We tap the views of a banker, a manager of a private equity fund, and an economist for insights into the current and future fortunes of the nation’s most important energy play.]
The bankable Permian Basin—that’s clearly been a story that’s come to fullest fruition in the past year, if by “bankable” we mean a region that has won the attention and the dollars not just of Permian Basin investors and lenders, but of investors and lenders on the larger stage of Wall Street and even the international financial markets.
Nothing validates an industry more than money—other people’s money. The Permian Basin has become a magnet for money on a grand scale, and not just quick cash but money that is invested with a confidence of stability over the long haul.
A study of the economies of U.S. metro areas conducted by IHS and Global Insight to gauge those cities’ success at recovering from the recession of 2008-2010 was completed and its results were published at the outset of this year, and of the 363 metro areas that were charted, numbers 1 and 2 were Midland and Odessa, the sister cities that comprise the heart of the Permian Basin. The study, which was prepared for the U.S. Conference of Mayors, concluded that “the North American energy boom will continue to create jobs, investment, and a competitive advantage in manufacturing.”
Those encouraging findings are nowhere more applicable than in the Permian Basin, which increasingly has been cited nationally as the very symbol of what is going well for the U.S. economy in 2014.
PBOG spoke with three individuals who have close acquaintance with the economic fortunes of the Permian, to glean what insights they have into the financial comeuppance of the region, and we share their feedback as our concluding installment of this “Wellspring of Success” series.
Frost Cochran is managing director of Post Oak Energy Capital, a Houston-based private equity fund that invests in “North American oil and gas companies, oil field services, and related infrastructure,” with a significant portion of that investment being in the Permian Basin.
Asked what he finds most appealing about the Permian from the investment standpoint, Cochran replied that the region is a legacy area where Post Oak has almost always had investments since the firm was started in 2006.
“And then some of us are operators by background and before we started our fund we actually operated as producers in the Basin,” he said. “So we’ve been involved in the area for a very long period of time.”
There is a tremendous amount of interest from the investment community in the Basin now, because of the evolution of technology that has created a renaissance of economic drilling activity, Cochran said.
“That seems to happen in cycles, and the latest evolution in technology, which was horizontal drilling and completion technology, just happened to be much more applicable in terms of increasing the economic viability of the Permian Basin than other regions,” Cochran said. “For instance, the last [previous] major evolution of technology was seismic driven, which really didn’t do that much for the Permian Basin. It did a lot for the Gulf Coast, in Louisiana, but it didn’t do a lot for the Permian. So our [Post Oak’s] interest in the area is being driven by the increase in commodity prices, which makes the area attractive to begin with, but secondarily by the increase in the evolution of using unconventional technology in conventional reservoirs. And the Permian generally is a conventional reservoir, with the exception of a couple of the newer resource plays in the area.”
Cochran said that at Post Oak “some of us have old family roots” in the Permian area, and that the business has a longstanding relationship with the Black family in Midland, “among other investments we’ve made in the area.”
As for his feelings about the anticipated longevity of the current boom in the Permian and other resource plays, Cochran had several points to share.
“Generally speaking, investors in North America have a view that, one, the United States is a place where you want to invest, because the U.S. economy is going to continue to grow,” he said. “It would be ideal there to achieve energy independence, for many reasons, and besides, investing in natural resources is a great long-term hedge against inflation and other hazards to financial investing. So I think the market is generally taking a very long-term view, now, of the oil and gas business in North America, not just the Permian Basin.”
But as for the Permian Basin, that play has a special appeal, according to Cochran.
“The Permian Basin is a particularly long-life type of asset or basin when you turn production on, and therefore you are getting something akin to buying a long duration bond. You are going to get a very long term investment in the area, not just a ‘quick payout’ type of financial trade. And that lends to the attractiveness of the area to the financial community,” he said. “And the infrastructure is there. The professional base is there.
“Texas is an industry friendly environment,” he added. “It is not like the Gulf of Mexico and federal waters, where the government might wake up some day and impose a drilling moratorium. It has all of the attractive attributes from a long-term investor’s perspective. And in this market, where there is a lot of uncertainty and concern about inflation in the market, as long as you feel like North America is on a stable foundation and is going to be growing, albeit at maybe a slow rate, the Permian Basin is, among all the basins in North America, a very attractive place to put long-term capital investment. Because the life of the asset is long, the regulatory environment is right [in Texas], and all of the infrastructure [in the Permian] generally exists, today, to serve the market.”
Teaming Up
Another Houstonian who has ties to the Midland area and who now is active as an energy lender in that region (in addition to other resource plays around the country) is Bill Brown, senior vice president at Cadence Bank.
Brown likes the opportunities posed by the Permian, and like Cochran, he has a level of comfort there that comes from his relationships in the area.
“I grew up in Midland and the guy who runs our [energy lending] group grew up in Odessa. One of our engineers is from Midland. So we have that familiarity that makes it a little bit easier for us than for someone just coming in from the outside. It’s a little easier for us to get into the flow of deals, based on relationships.”
With the size of the loans being made to Permian businesses growing ever larger, the financing packages have become ever more participatory, often involving multiple lending institutions, and that evolution has meant that lending institutions in places like Midland and Odessa have partnered with banks in Dallas, Houston, or other financial centers. Cadence Bank has partnered with, for instance, West Texas National Bank (WTNB), a Midland institution. Chris Whigham, an energy lender at WTNB, was quoted last month in PBOG about this phenomenon of local banks meeting higher loan amounts by teaming with other banks, both within and without the Permian.
And as Whigham observed in our article in the February issue, a lot of the international money that makes its way into the Permian Basin is not readily identifiable as “international” money because so much of it is channeled through the big energy lending institutions in Dallas and Houston—especially Houston.
Cadence Bank is one of those banks outside the Permian Basin, and then Cadence itself, with its Houston connections, in turn serves as an entry point for other lending institutions—some larger than Cadence—that want to team up on Permian-based deals. “Those teams are generally larger banks in Houston or Dallas that have put larger financings together. We’ve done those kinds of transactions, as well as smaller one- or two- or three-bank deals,” Brown said.
He described Cadence Bank as a traditional commercial bank. “We’re in the business of making loans, and there’s a lot of opportunity right now, whether it’s on the upstream side, the midstream, or the service side. We bank all three segments, across the country. But we have a particular interest in the Permian and West Texas.”
Like Cochran, Brown said he has been aware of the heightened interest in the Permian Basin shown by Wall Street. Like Cochran, he sees it as part of a larger phenomenon.
“I think there are a lot smarter guys than me out there looking at this stuff, but if you look at where the domestic industry is, at where the activity is, you see that it’s really in four places,” Brown said. “It’s in West Texas, it’s in South Texas, it’s in the Bakken, and it’s in the Marcellus/Utica areas. So the Permian Basin is one of the ‘Big Four,’ to begin with, and then I think that because there is such a history of the industry out in the Permian, everyone sort of expects to be looking at the Permian, whereas the Bakken is a newer play, and the Marcellus and Utica are newer plays. I think that one of the things that attracts us, too, is the fact that there are also experienced management teams and experienced labor pools out there in the Permian to do the work. It’s not the first time those folks have been through something like this.”
Brown himself concentrates on midstream deals. As noted earlier, Cadence has organized its energy lending side into three teams: upstream, midstream, and service. Brown heads the midstream division. All of its senior lenders have 20 years or more experience, and the upstream division employs a couple of engineers as well. Brown said it was somewhat unique for a bank to have a dedicated midstream team, and he feels that that gives them added focus and the advantage of a better informational perspective, on the midstream side.
“For every dollar that is being spent to drill wells, there are additional dollars are being spent to move those products to market,” he said. “And with all the infrastructure investment going into a place like West Texas, I find that a lot of people are surprised to hear about that. They surprised that, for as long as there has been production out there, that there is not sufficient infrastructure out there already. But it’s just not all in the right place. So those situations provide us with opportunities to partner up with management teams to go out and help finance our share of a pipeline or what-have-you.”
This Spectacular Turn of Events
Karr Ingham, a professional petroleum economist who is the founder of Amarillo-based Ingham Economic Reporting, sees the Permian “phenomenon,” like these other observers, as something with influence far beyond its own geographic locale. He also sees it as a phenomenon that holds a lesson for the ages.
To explain that, Ingham takes us back more than a decade.
“Those who were connected to the industry in the early part of the decade of the 2000s would recall what conditions were like then for oil and gas,” he remarked. “In 2002, in the latter part of the year, crude oil prices began to rise. They were then in the $20 to $25 range [per barrel]. They started to go up, and they kept going up for almost six whole years—from 2002 to 2008. During that period crude oil prices climbed to—well, I think the highest daily price was $147 a barrel, reached in mid-2008. And during all this six-year period of time, when all of this was going on, you would have thought that, good grief, the world was coming to an end. The news media, the political types, the consuming public—whether you were involved with the industry or not, you were awake and breathing and watching the news, and so you witnessed the hysteria over the rising crude prices. I mean, to hear them tell it, with crude oil prices going up, this one and only occurrence, which was crude oil prices going higher than they were, was going to change the economy. It was ‘causing inflation,’ it was ‘cutting into consumer and business speeding’ and doing so to such a degree that ‘the economy just had to go into recession.’”
But when the country finally did go into a recession in 2008, that recession had nothing to do with crude oil. It had, Ingham said, everything to do with
financial markets and housing and other economic issues that got far out of balance. “The energy markets had nothing to do with that,” he said. “Crude oil prices went down in 2008. It wasn’t crude oil prices that caused a recession—it was a recession, instead, that caused crude oil prices to go down. And natural gas prices. So the point of that is, in the context of all this [energy boom] that we are watching happen right now, all these fantastic increases in crude oil production nationally and in Texas, and the fact that we have cut our crude oil imports from 65 percent to 40 percent, plus the fact that Texas is now making up 30-plus percent of the country’s crude oil production rather than 20—well, none of this happens if crude oil stays at 20 bucks a barrel!
“And yet, if you asked anybody on the planet, probably including me, back in the early 2000s, the question ‘Would we be better off with crude oil at 25 dollars a barrel, rather than at $100 a barrel?’ well, that would have sounded so awful. It was inconceivable at that time. And yet those things that we could not predict—these things that caused all this wailing and gnashing of teeth—turned out to be the catalyst for all this spectacular turn of events that we are now witnessing play out before our very eyes.”
Ingham was referring to the fact that, unless the price of oil had soared to the heights it reached in the decade of the 2000s, the breakthrough technologies that we now enjoy likely never would have been pioneered.
“So this is the message to the political world, to the people who would have curtailed that economic series of events,” Ingham said. “Whether you are trying to look five years into the future or ten or twenty—if you think you can envision a better set of circumstances for us than the market itself would create, you’d be wrong. Let the markets do what markets are ‘designed’ to do. And that is, solve our problems for us. Whether we know they are solving our problems for us or not. That is exactly what they are doing, and if we had somehow managed to artificially stymie this, and put price controls in place or some ridiculous thing like that—which was actually discussed at length during that period of time—none of this would be occurring right now.
“That, to me, is the big picture takeaway from all of this,” he said in conclusion. “We don’t know where we’re gonna end up, because we are still watching it play out. But I’m loving what I’m seeing right now.”
Brown on Market Confidence
Cadence Bank Senior Vice President Bill Brown, a Houston-based energy lender with ties to the Permian Basin, said that commodity prices are key to maintaining investment levels in the Permian Basin, and that the financial markets appear to be confident that those prices are going to remain relatively stable.
Asked if he is confident in the longevity of the current boom, Brown was similarly positive.
“I am, yes,” Brown said, adding, “We’ve all seen all the bumper stickers, right? It’s a cyclical business. We all know that. And what drives cyclicality is price. I had a guy tell me years ago, ‘Trees don’t grow to the sky.’ Price isn’t going to go up forever. But there is a price at which investments will continue to be made, and we’re well above that price today. So, hopefully, the global recovery that is going on will continue to drive demand and that will keep prices strong or moderately strong, and that’s what will provide the incentive to make the investments.”
Brown said that he is seeing interest in the Permian Basin from banks and bankers who had not, to his knowledge, shown interest in the region previously.
“There are lots of banks that have been doing business in the area for a long time,” said Brown, whose bank (Cadence Bank) often partners with multiple banks in funding large energy financing packages. Like others who work the West Texas marketplace, he is familiar with many of the regulars that work this territory. “But we’ve also had some folks that are with some of the international banks that have not been active in the area that have expressed an interest in working with us. And getting an ‘in’ with some of the companies out in the Permian. So that is an interesting twist. These are folks who are a bit newer to the industry space and who want to work with someone who has been there before.
“But there’s another point that I want to make, and that is that we [Cadence Bank] are certainly not a come-and-gone kind of outfit,” Brown said. “We’ve seen these cycles in the past. We are a privately held bank and our board is made up of guys who have had very successful careers in banking and are generally retired and who launched this company to start a new bank. And all of these guys have had success in their connections to the energy industry. This is not just a ‘Boy, there’s a lot of money to be made and let’s dive in and we’ll jump out at the first sign of trouble.’ But yes, there is a lot of interest from folks who don’t know the area and want to do all they can to just ‘get in on it,’ so to speak.”
Cochran on Unconventionality
Asked about the Permian Basin’s higher profile in the financial marketplace, Frost Cochran, managing director of Post Oak Energy Capital, a Houston-based private equity fund manager, agreed that this region has gained greater attention. And he agreed, too, that more money is flowing into the area. “Yes, on both accounts,” said Cochran. “I would say that the financial community was always aware of the Permian Basin, just as it has always been aware of the Appalachian Basin, but I think most [investors] were of the opinion that these were relatively mature, fully exploited legacy provinces. It’s been the combination of higher commodity prices and improved technology that has created a renaissance in those mature, conventional basins and has woken up Wall Street and turned on, generally, the interests of the financial community in those area.”
Cochran indicated that the investment community’s view of the oil patch, and the oil and gas industry’s view of the oil patch, are views that are sometimes at variance.
As for the Permian Basin in particular, Cochran said that its resurgence is not unlike what has happened in other legacy basins.
“I think most people still continue to be surprised, quarter after quarter, at how much incremental opportunity there is in a basin that appeared to be so mature to so many folks,” he said. “It’s almost like the current generation of folks in the financial community—the below 60 or maybe below 55s—considered the region as “done” and fully exploited. They have woken up and are taking note that, in most respects, no basin is ever done and fully exploited. That’s because there is a tremendous amount of oil in place and the initial recovery was just a small fraction of what was in place. So you can always go back to an old basin, which is where the oil is, with new technology.
“And that realization is dawning on this younger financial community,” he added, “that this is in fact the way the oil and gas business has always worked. And I think some of that comes down to not understanding the nature of the oil and gas business. It is not just like a container of oil that you just pour out and then it’s empty. It’s oil-saturated rock from which you are only getting a little recovery when you try to produce it.”