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AAPG Southwest Section Annual Convention

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Attracting Capital: Why the Rules Change


The investors and lenders who are the source of oil and gas capital change depending on commodity prices, interest rates, and the regulatory environment. As the investors change, the economic goals and priorities that the investors require of their industry partners also change. Prior to Sarbanes Oxley (SOX) in 2002, which was largely a response to the Enron collapse, and to Dodd Frank in 2010, which was a response to the 2008 financial recession, small (less than $100 million enterprise value) oil and gas companies could raise public equity to fund their operations. Common practice in conventional oil and gas prior to SOX was to fund exploratory wells with cash-flow from operations and to fund development wells with reserve-based lending from banks. The most common economic metrics for oil and gas companies during this period was their finding and developing cost and their exploration success rate. Note that neither of these metrics translated directly to rate of return or cash flow, because that calculation would require knowledge of future commodity prices, production rates and operating costs, etc. The onset of widespread unconventional oil and gas development post-2008 created a huge demand for capital at a time when it was difficult for small entrepreneurial companies to obtain public equity or conventional bank financing. Private equity filled this capital gap at a time when many new unconventional plays were being tested and large areas of resource were being proven. At the same time, accounting practices to qualify proved undeveloped reserves (PUD) changed to accommodate unconventional technology and as a result, reserve-based metrics were subject to a type of inflation. Since 2015, the industry has seen increased commodity price volatility, downward price pressure and rising interest rates, along with PUD inflation. Lenders and investors have responded by moving away from reserve- based metrics to cash-flow metrics which value producing reserves more than metrics that put a large value on PUD. These metrics require accurate commodity price prediction to be of value which can be somewhat mitigated through aggressive hedging.