"IRVING, Texas--(BUSINESS WIRE)--Exxon Mobil Corporation (NYSE:XOM) said today it will more than double its Permian Basin resource to 6 billion barrels of oil equivalent through the acquisition of companies owned by the Bass family of Fort Worth, Texas, with an estimated resource of 3.4 billion barrels of oil equivalent in New Mexico's Delaware Basin, a highly prolific, oil-prone section of the Permian Basin. "
This is a fairly significant even by Permian standards. Exxon Mobil will pay potentially up to $6.6 billion for this opportunity depending upon results. In keeping with the company's conservative style, the acquisition is being made using company stock. The majors traditionally wait for a track record, but when that favorable track record appears, then they are usually willing to pay for it. Other companies can go first, take larger risks and obtain larger rewards. Exxon has traditionally done well with this strategy overall.
But when large companies like Exxon are heading to the Permian, then the most significant capital gains may have already been made for investors. Previous track records look excellent, but the past may not predict the future. Especially in a cyclical industry like oil and gas exploration. The number of companies that are selling stock with significant Permian operations should also be a warning about future capital gains.
This does not mean that the party is over. In fact, the Permian can get far more over-heated than the current situation. But it does indicate that capital gains are becoming more dangerous and the risk of loss is rising. It has only been a few years since the large commodity price decline. A lot of companies looked great all the way down before they filed bankruptcy or issued a lot of shares. In the future, history may be about to repeat itself.
Another sign is that a major player, Blackstone Energy Partners (and GSO Capital Partners) consider the Eagleford to be a relative bargain. Blackstone not only purchased a 50% part of the Sanchez Energy (NYSE:SN) purchase, it also funded one of the Sanchez Energy subsidiaries to the tune of about $500 million of preferred stock through another subsidiary.
Both of these areas contain multiple prospects. Some of the intervals are unevaluated at this time. The geology is different and the cost differentials in the eyes of many represent the advantages of the Permian. Still, from the financing that Blackstone provided, it is clear that Blackstone thought the purchase was a good deal. In the eyes of Blackstone, the Permian could be relatively expensive with too much above average expectations in the pricing. The Bass family is not going to sell unless they thought they were getting a good selling price for their holdings. So some major players are beginning to vote to either leave the Permian or stay away from the Permian at current pricing. That is definitely a trend to continue watching.
Admittedly, Exxon Mobil is not known for overpaying on deals. Plus this deal in particular may not be that material to the company one way or another. But Exxon is also not known for taking a lot of gigantic risks either. This was probably a safe purchase with an expected above average return. But a lot of Permian company stocks already have above average returns priced into their stocks. So it would take unexpectedly large above average returns to lead to future capital gains to make the investment worthwhile.
Blackstone, on the other hand, opted for a far lower purchase price with a very significant payback. The 132 DUCs will provide about a 100% return on the investment to bring them to completion. This is the finance definition of instant cash flow improvement. No miracles needed. Just good solid operational results. That is the kind of thing that entices Blackstone in the first place. It gives the drilling program time to take effect and show the expected results. Operational improvements will be icing on the cake and would leave to some excellent capital gains.
So while Sanchez Energy is definitely leveraged to the hilt (and then some), the "instant cash flow increase" from the DUCs provides a margin of safety not often seen in leveraged deals. Lower oil prices could still hurt, but there is a hedging program that could mitigate some of the damage. In a race against time in a lower oil price environment, those DUCs could turn the tide in the favor of both Sanchez and Blackstone. Projected operational improvements could easily provide any additional lower costs needed. There is no "Permian Charm" premium to overcome.
Those kinds of benefits are the signs of a bargain. The less strain on future operations to make the deal look good the better. So maybe it is time for Permian prices to slow their ascent.
Disclaimer: I am not a registered investment advisor, and this article is not to be construed as an offer to purchase or sell stock. All investors are recommended to read all the filings of the company and the press releases to assess for themselves whether or not this company fits their investment risk profile.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.