“To me, if I think about what the optimal E&P sector looks like, in the U.S. I would think you’d have 10 or 15 of them, and all of them would be net-zero. All of them would have best-in-class boards. All of them would have the compensation aligned with shareholders based on equity performance. I would expect dividend yields of 5-10%, no real growth, returning excess cash to shareholders, and return on capital employed that consistently outperforms their cost of capital. That’s how we’re trying to remake the industry. The easiest way to do this is to go acquire a company and demonstrate that you can do it.”
As the consolidation of the upstream, E&P sector of the U.S. shale business continues to heat up, there is debate over whether it is taking place too slowly, just fast enough, or too quickly for the good of the industry. Based on the quote above, you can put Ben Dell, Chairman of the Board at DJ Basin producer Civitas and Managing Partner at the Kimmeridge Energy Management private equity company, down on the side of “too slowly.”
Even two years into this current consolidation phase, Enverus lists 19 sizable corporate operators in the Permian Basin alone, and that doesn’t include the dozens of smaller corporate entities, partnerships and privately held companies who drill and produce oil and gas in that single basin. Thus, winnowing it all down to 10 to 15 E&P companies nationally is going to take a lot of work and capital, but Dell - whose career in the industry began as a geologist at BP in 1998, the advent of a previous major wave of consolidation - believes it is work the industry desperately needs to complete.
“We had a lost decade in chasing growth in an industry that didn’t really need growth, destroyed a lot of shareholder value,” he told me in a recent interview. “There’s been over $350 billion in book value written off in the last decade in the E&P space alone. And really, the investor base is at the end of their tether.” The truth in those statements should be obvious to anyone who has kept up with events in the industry since the shale oil boom began in earnest in 2009.
“That’s all coincided with this ESG narrative,” Dell continued, “and you can debate which one came first, but it’s been accelerated in my view by COVID. But you’re finally at a turning point in the industry where you are beginning to see what I call the three pillars of reform to actually make the sector investible again. This is important because this sector has got a long way to run. It’s not going to be done in 10 years - probably won’t be done in 50 years if we’re brutally honest about it - and there’s a lot of profitability still to be generated.”
Dell’s three pillars include:
- Establishing a profitable business model that creates a return above the cost of capital and returns free cash flow to investors;
- Establishing a corporate governance model that is aligned with the goals of investors and which bases executive compensation on metrics aligned with those goals; and
- Getting to net-zero on emissions.
Regarding that third point, Dell asks, “One of the things I ask people is, if all the E&Ps were net zero and have no carbon footprint, or if you could sequester carbon for a dollar, would you change any of the energy infrastructure you have today? And most people say ‘no,’” he said. “Because, why would you change it? It works well, it’s very functional. Why would you invest trillions of dollars in something else if what you already have works?” Good question.
“For the E&Ps, the question right now is do they have a license to operate?” Dell continued. “My view is, if you are net-zero, you are earning your license to operate. If the entire E&P space is net-zero, why wouldn’t you have it? What is the argument at that point? Then it’s just politics, and some people will say, well, I just don’t like it. Some people just hate the industry, and you can’t really address that. But that’s not really a strong, sticking argument over time. So, my goal is to be net-zero.”
Dell believes that the entire E&P industry, and ultimately every step in the oil and gas supply chain, is going to have to get to net zero in order to retain its license to operate in the United States. “We saw Devon come out with a commitment by 2050, Diamondback has done it, everyone’s ultimately going to follow suit. It’s an inevitability,” he said.
“We want to be at the forefront of that movement. We want to set the standard. And if you can, you want to attract capital, to get a lower cost of capital, because if you can trade at a premium, it can only help you accelerate consolidation by taking out the poor performers in the basin.”
Dell’s and Kimmeridge’s campaign to consolidate the E&P sector in the DJ Basin has moved rapidly in recent weeks, announcing the merger between Bonanza Creek and Extraction Oil & Gas on May 7 and the subsequent acquisition of Crestone Peak Resources a month later to form what will become the largest producer in the Basin when the deals are completed.
“Governance in this industry has been atrocious,” Dell said. “It’s been atrocious for years, people being compensated for the wrong metrics, management being compensated when they’ve destroyed value, and there needs to be a real alignment with shareholders. Shareholders don’t mind if management get paid when they’re making money, but over the last decade we’ve watched E&P managers get paid 10, 12, 15 million dollars a year while destroying shareholder value. It’s absurd, and the boards have let it happen.
“So now we’re starting to see a governance revolution, and it was hard at first because the question was always ‘show me someone else who’s doing it,’ and there wasn’t anyone.”
With two mergers in the span of a month, Dell has created his own case study at Civitas. If it all works according to his vision, those who hate the industry for the sake of hating it will soon be looking for new narratives to spin.
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