Independent geologists need to generate
good ideas -- but good ideas go only so far.
To succeed in today's world independents must couple
scientific knowledge with business savvy -- and much of that business
acumen must be centered on where and how to generate financing.
Business knowledge is so important for today's geologists
that professional societies are offering myriad courses, presentations
and technical sessions covering the dos and don'ts of energy business
and financing. That includes AAPG, which at the Dallas AAPG Annual
Meeting placed oil and gas financing center stage for a DPA forum
on "Technical, Business and Ethical Challenges for Independents
Since investors are looking for future returns, a
look at the future pricing is always part of the financing conversation.
Richard G. Green, with LaRoche Petroleum Consultants
in Dallas, said the history of the oil industry has repeated periods
of both low and high prices -- and there is no reason to believe
the future will hold a different scenario.
Except, that is, for the whale of a wild card in
the form of the "Hubbert Curve" theory of declining supply, which
will throw price equilibrium into an upward who knows what.
For the short term, Green sees oil prices entering
a new pricing plateau of around $40 as a baseline. He also projects
prices at or near $60 in about three years or so, which will cause
a number of factors to kick in, including the spark for increased
alternative energy sources such as oil shales, tar sands, and gas-to-liquid
technologies to become economic supply sources.
Other speakers also offered advice and experiences
in the business side of geology. Here's a sampling of what three
of them had to say:
Go Outside the Box
Obtaining capital to finance a project or start-up
company can be as difficult as developing a prospect or putting
together a well-rounded management team, said Edward P. Travis with
LaRoche Petroleum Consultants.
"It is important for independents to have a clear
vision of their idea or project and which of the various types of
debt structure is the best fit," he said.
Travis outlined several types of financing best suited
to independent geologists during his talk, "How Much Can I Borrow?
The Fundamentals of Energy Financing."
The four primary financing options include:
1. Traditional bank debt.
"This is ordinarily low cost money, tied to the prime interest
rate," he said, "but the problem is banks won't advance you a
whole lot of your project's worth. For instance, if an independent
geologist values a project at $3 million, a bank will only finance
50 to 70 percent of that -- and only then if it is less risky
2. Mezzanine debt.
With this, independents typically get a greater percentage of
a project's value -- but the project has to have a lot of development
"This is riskier capital than traditional bank debt, because
these lenders put more constraints on you," he said. "If you are
not successful they pick up more ownership and control in your
company, which means these groups are willing to fund a riskier
This option requires a project with a lot of success potential,
he said, but "if you are successful, mezzanine debt is normally
paid off in a relatively short time."
3. Private equity.
This can involve family, friends, private investors or venture
capitalists who are typically investing in a proven management
team -- and they typically want you to invest your own money as
"This option takes money to get money, and you have to have
a relatively proven track record," he said.
4. Industry joint venture capital.
With this, you bring a company an idea and they fund your share.
"This is expensive money," Travis said, "because the other company
is putting up the capital. But it does allow you over time to
develop a track record, which is important to attract other types
Travis also offered examples of projects and which
financing options would be best suited for each:
- For an evaluation geologist or engineer who is buying producing
properties or overrides in properties -- something that is already
on line -- "you are going to have a difficult time getting mezzanine
funding," he said, "because there are not a lot of development
drilling opportunities. Traditional bank debt is likely the best
choice for this type of program."
- For an independent geologist who has identified a lease with
one producing well and three offset well locations with potentially
untested fault blocks adjacent to those locations, "the local
bank is not the place to go," he said. "This type of project is
too high risk for traditional bank debt, so the best bet is mezzanine
financing, private equity or a joint venture, depending on other
factors in the deal."
- For an independent with a proven track record with a strong
company who may have developed some excellent ideas, but who can't
get money from the local bank because the new venture has no assets,
"private equity is the best option," he said. "These lenders will
invest in a management team, although they will own 80 to 90 percent
of the new venture and require the independent to put up the rest
of the money.
"Too often we see people who have a really good idea
but haven't figured out where to go to look for financing," Travis
said. "The most asked question we get is 'How much will a bank loan
me?' If somebody is asking that question they really don't understand
the fundamentals of energy financing.
"Independents need to think outside the traditional
bank debt box," he added. "There is not a shortage of money for
this industry today -- commodity prices are so high that there is
an infusion of capital into our business -- but you have to know
how and where to get it."
Plan, Plan, Plan
G. Warfield "Skip" Hobbs, with Ammonite Resources,
presented a paper on "Preparing a Business Plan for a Petroleum
Exploration and Production Venture: A Critical Step in Launching
a Successful Enterprise."
Developing a comprehensive business plan, he said,
is crucial to accessing capital.
"Business plans help companies think about their
goals and challenges and how they can realistically achieve those
goals," he said. "A business plan is more than just a spreadsheet
-- we call it an information memorandum that lays out a business
strategy in terms of time and costs."
An effective plan should have at least five sections:
1. An executive summary providing background information on the
"What oil and gas people have to realize is that,
from an investor's standpoint, the 'who' is more important than
the 'what,' because of the miserable track record of oil and gas
investing, particularly with small companies," he said.
"Can you demonstrate you have the ability to create
shareholder value? Do you have experience in executing the business
plan you have laid out? If your experience is Gulf Coast, should
you really be exploring the Rockies for tight gas?
2. What does your company plan to do, what will it cost and what
is the expected return?
Investors have a huge stack of submittals on their
desk at any given time, Hobbs said, so "include bells and whistles
... that show why the project is better than the others investors
also are reviewing.
"The way to do that is by showing the expected return,"
he added. "Most companies have historically not done the economics."
3. A geologic summary and an economic analysis on a discounted
cash flow basis, so the capital providers can compare "apples to
"You can no longer show a back-of-the-envelope economic
analysis to a sophisticated investor," Hobbs said. "They want to
see a spreadsheet showing a discounted cash flow analysis."
4. Project risks -- extremely important, Hobbs said, to avoid
any U.S. Securities and Exchange Commission scrutiny.
"By legal definition, because of the abuses in oil
and gas and mining over the years, if you misrepresent a prospect
and somebody sues you claiming securities fraud, you are subject
to an entirely different set of rules and regulations," he said.
"And those are stacked against you, so it is imperative to realistically
present all the risks of a project."
5. The transaction structure (whether that is overrides, back-ins,
carried interests or some other option).
"There is an art to writing these business plans
and there is a relatively standard format," he said. "A company
greatly enhances its chances of attracting capital if they take
the time to put together a comprehensive, well thought-out business
Both Sides Now
Robert Gershen, president, chief executive officer
and chairman of Longview Energy Co., gave his perspective on capital
formation from both sides of the fence; he formerly owned Associated
Energy Managers, which helped large institutions invest millions
in oil and gas ventures, and in 2002 took on the new role managing
a failing company.
"Some of these rules (of financing) seem simple,
but too many people don't understand or adhere to them," Gershen
- Don't borrow more money than you can repay.
"E&P companies should match the kind of money they get
with the kind of risk associated with the projects that money
will be used for," he said. "For example, the company I am now
running got in trouble because it used bank debt to drill wildcats."
- Know your financial partner, and make sure they know you.
"Closing the financing is the beginning, not the end, of the
relationship," he said.
Do not lie.
In terms of operations, "keep doing what you do and don't
chase the current fad."
"If you are a Rockies player and the current fad is the Gulf
of Mexico, don't try to move to the Gulf of Mexico just because
that's what the money wants," he said. "If you are an acquisition
company don't try to drill wildcats. In short, don't let the
money push you around."
- Being out of step is probably a good sign.
If what you are doing is what everybody else is doing you
are just part of the crowd -- and too often the crowd is wrong,"
he said. "Find your own strength and do it -- but know that
strength will come in and out of fashion with investors."
Gershen said he has learned some important lessons
in his career as both a financier and an oil and gas company executive.
"Two years ago when I was investing I was of the
opinion that having money was the most important thing," he said.
"I assumed that dollars would attract the best deals and that management
was a cost that needed to be limited and controlled. I assumed there
is always another deal, and the key to any deal is the original
Today? "Managing the relationship with money is an
important responsibility. Knowing and understanding whom you are
getting in bed with and, in fact, realizing you are getting in bed
with somebody is a key to success.