Private equity's future in US Gulf of Mexico deepwater

With many companies chasing onshore shale and white hot Brazil and Mexico, a changing dynamic in the Gulf of Mexico (GoM) has emerged with private equity-backed companies taking the lead. 

A new analysis by Wood Mackenzie, "Does private equity have a future in the deepwater US Gulf of Mexico?," explores what the future holds for these smaller, nimbler offshore players, from operational strategies and risks to potential exit strategies.

Michael Murphy, research analyst with Wood Mackenzie's GoM team, and lead author of the analysis, said: "With the region shifting from a period of expansion to a period of capital restraint, private equity-sponsored companies, focusing on investment discipline and efficiently commercialising prospects, have shown what it takes to compete."

Private equity-backed companies have shown a willingness to take a countercyclical investment approach in the Gulf of Mexico. Forecast development capital spend in the GoM is set to rise from a projected US$1 billion in 2018 to US$1.2 billion in 2020, a 20% increase. Meanwhile, Independents’ development capex is projected to decline over the same period, from US$1.4 billion in 2017 to US$1.0 billion in 2020.

Although the Majors represent the bulk of projected capital spend in the GoM for the foreseeable future, private equity-backed companies will play a larger role in the region long term. LLOG Exploration represents the largest proportion of projected private equity-backed activity, with higher complexity Lower Tertiary Buckskin expected to come online 2019, and the Khaleesi and Mormont fields in 2021

"Just as private equity's entrance into the US Lower 48 brought fresh impetus and renewed direction to exploration and production, private equity is bringing a different operational approach to the Gulf of Mexico," Mr Murphy said. "Capitalising on lower cost structures and focusing on quicker paybacks, these smaller, nimbler private equity-backed outfits have shown an ability to turn discoveries into dollars at a faster clip than their competition."

The average time from discovery to first oil for private equity-backed companies has been around three years for fields sanctioned since 2010, compared to around six years for most Majors and Independents. Moreover, many smaller players in the GoM have been able to add production at a lower cost than their larger counterparts. In fact, the average full-cycle capex in deepwater GoM now stands at around US$12 per barrel of oil equivalent (boe) for private equity-backed companies, about 40% lower than Independents.

Private capital is also playing a critical role in the rejuvenation of brownfield assets in the GoM. The scale of opportunity for private capital is exemplified by EnVen's redevelopment of its Brutus and Glider deepwater assets it, which it acquired from Shell in late 2016.  By targeting previously bypassed pay EnVen was able to increase production from these assets by nearly 30% from 2016 to 2018, an increase of approximately 18 thousand boe (kboe) per day to 23 kboe per day.

The biggest prize to be had however is in the development of ultra high-pressure (HP) fields. LLOG's stepped up working interest in the ultra HP Shenandoah field following the Cobalt bankruptcy demonstrates its willingness to take on larger risks as the value of its assets rival those of mid-size Independents. While the development of the technology to unlock ultra HP reservoirs is ongoing, it provides potential growth options with the nearby Yucutan and Coronado fields as examples.

"Ultimately, the ability to exploit untapped reservoirs will separate the players from the pretenders,"  Mr Murphy said. "Ultra-high pressure reservoir development offers the potential for higher growth, but the proof of concept remains to be seen. However, infrastructure-led exploration has provided companies with economic development opportunities. Recently, companies such as LLOG, Talos and Deep Gulf Energy have shown that value is there for those with the ability to execute and the willingness to take the risk."

The analysis also explored some of the challenges facing private equity-backed operators in the GoM in terms of the exit process. The recent Talos-Stone reverse IPO and acquisition of Deep Gulf Energy by Kosmos demonstrate potential exit paths. But there are barriers to exit. Talos had to get creative to go public and Deep Gulf Energy's major investment started thirteen years ago – a long journey to monetization.

"Deepwater could pose the Hotel California problem for private equity-funds, you can check in anytime you want but you can never leave," Mr Murphy said. "With a smaller buyer pool in deepwater, and Wall Street focused on tight oil and favouring companies with large share buy-back programs, private equity-backed companies will need to consolidate and grow their reserve base to become more attractive. This will provide stronger exit opportunities for funds looking to monetise assets."