Exxon Mobil's (NYSE:XOM) move to acquire Bopco in a ~$6 billion transaction comes as a positive surprise, not only as a capture of a promising asset at a reasonable price, but also as a possible indication that the company, which has been behind the curve in the shale game, is adjusting its strategy in the right direction.
While being a legacy producer in the Permian Basin, Exxon had missed many opportunities to be an "early mover" in the Basin's most promising plays, alongside its smaller, more aggressive peers. However, the company finally posted a transaction worth waiting for. The announced acquisition is of sufficient size to make a difference for Exxon's U.S. portfolio. The asset has high concentration and is located in a core area.
Thanks to the remarkable resilience of its stock throughout the downturn, Exxon remains favorably positioned to high-grade its unconventional asset portfolio without suffering value dilution, despite the M&A market for core shale properties being red-hot. Moreover, a case can be made that the company is facing an urgent need to pursue additional strategic initiatives similar to the one just announced, in order to improve the competitiveness of its Upstream business in the event the low-price environment in oil proves persistent.
Exxon's press release - which, in the oil major's usual style, is not particularly generous on information - states that the company is acquiring ~250,000 acres of leasehold in the Permian Basin, the bulk of which in contiguous, held-by-production units in the New Mexico Delaware Basin and an additional 25,000 leasehold acres in other areas. Production is ~18,000 Boe/d net, of which 70% is liquids.
Exxon is paying $5.6 billion in stock and up to $1 billion in contingent payments "commensurate with the development of the resource" that will be paid from 2020 but ending no later than 2032. (While no more specific disclosure was provided, it sounds that the contingent payments are akin to a royalty capped at $1 billion.)
Exxon has a massive legacy footprint in the Permian, with ~140,000 Boe/d of net production and 1.5 million-acre leasehold (the map below). However, the 1.5 million acre statistic is just as relevant as the 60 billion barrels of oil equivalent in place that Exxon heralded in its Bopco acquisition press release. The majority of Exxon's leases are mature properties, a big part of which are located on the Central Basin Platform. By looking at the map, one might get an impression that the company's acreage base in the Midland and Delaware Basins is also vast. However, it is important to take into consideration that a legacy vertical well does not always hold much in terms of "deep rights" acreage.
In the last few years, Exxon made (cautious) steps to add to its core position in the Permian. Holdings in the northern Midland Basin Wolfcamp play have increased above 100,000 net acres. Asset swaps with the now bankrupt LINN Energy and the farm-in on Endeavor Energy acreage in 2014 contributed to that growth.
(Source: Exxon Mobil, May 2015)
Still, prior to the Bopco announcement, Exxon's exposure to the Permian's most prolific plays, such as the Wolfcamp Core, had been insufficient to "move the needle" in the context of the company's $400 billion enterprise value. Moreover, given the Permian's emerging role as one of the most economic shale provinces in North America, Exxon's indecisiveness in capturing sweet-spot acreage has been outright disappointing. The Bopco acquisition addresses the issue to some degree, more than doubling the company's growth opportunity set in the Permian and providing a large, mostly contiguous block ready for multi-year exploitation.
Exxon did not find it necessary to provide a map of the acquisition acreage or any discussion of the underlying geology. To help readers, the drilling units that the press release mentioned are located primarily in the heart of the northern Delaware Basin in eastern Eddy County, New Mexico, east of U.S. 285 (the area is roughly outlined by the orange circle on the map below). A small portion of Bopco's leases can also be tracked in the adjacent Lea County, New Mexico and Winkler County, Texas. There are close to 400 producing wells, both vertical and horizontal, on the properties in New Mexico alone. The majority of oil production is from the Bone Spring zones.
The geology of this area is quite different from that in the Southern Delaware Basin where prices paid for acreage in recent M&A transactions have been the highest. In the Southern Delaware Basin, the Wolfcamp A and B within the oily fairway are typically viewed as the biggest prize. In the most sought-after areas, the Wolfcamp tends to be thick, overpressured and oily, yielding prolific, albeit expensive to drill, wells. Based on recent transactions, prices per undeveloped acre in such areas have moved into the $30,000-$40,000 range, with some price points exceeding $40,000. (While some recent transactions involving prolific acreage were done in the $25,000-$30,000 per acre range, they increasingly look to be an exception to the rule.) The differential valuations in the Southern Delaware Basin Core have merit, in my opinion.
In the area where Bopco operates, oil activity has traditionally been focused on the Bone Springs, Brushy Canyon and Avalon and, to a lesser degree, other targets. EURs are typically smaller but the oil cut tends to be relatively high and wells are less expensive to drill (often in the $3-$4 million range for single-section laterals in the shallower zones). More recently, very impressive results have been also demonstrated in the Wolfcamp A-XY. The Wolfcamp B tends to be gassier and more expensive in terms of well costs, but is also promising.
While current development activity across the basin requires horizontal fracturing techniques in almost all cases, the primary target zones in the northern Delaware Basin - the three Bone Springs and Wolfcamp A-XY - are semi-conventional plays, whereas the Wolfcamp A and B in the southern Delaware Basin are "true shales" that have the appeal of yielding reasonably predictable results and being developed on high-density patterns. Decline characteristics can also be quite different.
If I attribute a ~$600-$900 million M&A value to Bopco's existing production, midstream assets and the 25,000 net acres outside New Mexico, and if I value the earn-outs at $300 million (to reflect the time value of money and uncertainty), the implied price being paid for the undeveloped acreage in New Mexico comes out at $5.1-$5.3 billion. If I further assume that the acreage is 15% developed (in the most attractive and currently delineated target zones), the implied price paid per undeveloped acre is ~$23,000-$25,000.
Given the highly concentrated nature of the acquired acreage, its HBP status and significant captured resource potential, the price being paid appears to be quite reasonable. Perhaps the most relevant comparable transaction - both in terms of size, location, stock-for-stock structure and ownership context - is the recent acquisition of Yates Petroleum by EOG Resources (NYSE:EOG). At the time of the Yates deal announcement, I estimated that EOG effectively paid under $10,000 per acre in the Delaware Basin. However, the location and concentration of the Bopco block easily justify the higher price paid by Exxon, in my opinion (let alone the higher oil prices and more competitive M&A environment).
Accelerating the value of the most attractive drilling locations is one of the ways to reduce the impact of the large upfront investment. Given the size of Exxon's annual budget, capital re-allocation from lower-return projects could provide such acceleration.
Overall, I interpret the acquisition as a positive development for Exxon. However, the bigger question in this regard is, is it just a one-off initiative to "check the box" against shale activity or a harbinger or a strategic repositioning towards the lowest risk, highest return areas that appears necessary under a lower-for-longer scenario?
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