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Rick Fritz - Building a PE Company: Steps, Dos, and Don'ts

Moneymakers Business Forum | 2019 Oklahoma City

Moneymakers Business Forum | 2019 Oklahoma City

Summary

Building a PE Company: Steps, Dos, and Don'ts. A Moneymaker Forum talk given by Rick Fritz, Fritz Energy Partners in Oklahoma City, Oklahoma on 4 April, 2019.

Private equity companies in the oil and gas business play similar roles to venture capitalist in other startup businesses like high-tech. This is an opportunity for entrepreneurs to develop new ideas with significant funding. Success is greatly rewarded. Failure is not an option. As a result, private equity or PE provides millions of dollars to teams working in North American resource plays.

There are several steps to building a PE company. Refreshingly, the first and perhaps most important step is the development of a team. Key team members include a good to great financial officer, two geology gurus—both a seasoned oil finder and sophisticated petrophysicist, an aggressive, senior landman not adverse to buying HBP properties, a business development entrepreneur—usually a reservoir engineer (and/or a landman), and a disciplined, cost-driven operations engineer. In most cases there is a team builder—a success financier or it can be a small group of high-net-value individuals.

The second step (defined by the first) is the overall type of team. Oil and gas PE companies tend to be engineering-dominated or geology-dominated. Engineering-dominated private equity companies are more common and they focus on purchasing packages and spend a lot of time data rooms and bidding. Geology-dominated teams tend to focus on grassroots plays and typically purchase acreage through original leases or through small HBP packages.

Step three is to define a business model which fits the team...or vice versa. There are multiple business models for of oil and gas private equity companies. The dominant model during the resource oil and gas boom was the “buy and flip” model. This model involves acquiring undervalued properties at low prices, drilling a few wells for proof-of-concept and monetizing within 3-5 years (the shorter the better). A successful buy and flip model requires healthy, aggressive public companies competing for new properties. With current poor market conditions due to the retreat of public companies, the “purchase and produce” model is in vogue. This model involves buying producing properties and using new technology and methods to develop. This tried and true plan provides long term returns with less risk although you typically to not see the high 3-5x returns. Other more niche business models include “ID & buy minerals” and, of course, mid-stream PE companies.

There is a fourth step which is picking the PE company for a financial sponsor or rather getting the right one to pick your team. This is a complicated process that requires a lot of research. It is beyond the scope of this paper and will not be addressed except as already discussed above.

Execution is the next step. It leads to monetization which is the overarching goal. In developing a PE company, the prime directive is “return on investment.”. The entire team must focus on profit—that is why I listed the CFO first. As said earlier, “Failure in not an option”. That said it is surprising there is not more “How to” information available on building a PE company, That is the purpose of the remainder of this paper—Dos and Don’ts.

Full Transcript

How many knows-- how many out here actually knows where powerhouse is? Do you know what a powerhouse is? Wow.

I was raised-- my dad ran two powerhouses, and a powerhouse, that's the most efficient way they used to drill-- they used to pump shallow wells. It would have had a giant engine with about a foot diameter piston. And then it had this huge belt. It was a foot wide, and it ran down on this big-- it looked like a bicycle wheel on its side, and it was about 30 feet across and the belt went around that. It was an offset cam on the bottom.

And so the way it popped is it went around. It would make this horizontal movement, and these rod lines went out, and they pumped the wells. So it's like amazing feat of mankind, all the moving parts on it. Well, the way you started that, the way you started that is you would-- they had these two six foot cast iron flywheels, and they had six spokes on them. And you would jump up as high as you can, put your foot down in about halfway, and you throw it backwards, and get all, and it would backfire. It would go, boom, and take off.

And so what was the hardest part of that? Getting off. Getting off in time. And so that's kind of what I'm talking about today a little bit, but I remember one time we went out there, and my dad, he's a big, big guy. And we were in a hurry. It's wet, and he jumped up on that flywheel, brought it down, and his foot slipped and went right through spoke. And I remember watching I think come around.

Above it was one. It was going to kick, and it didn't, fortunately. And he looked at me, and he says, that was close. And it was close.

So a lot of these timing, all these things are close. And what I want to talk to you today about is just some-- what we've learned from experience. This the first time, I think, I've done a slideshow without any figures. So mainly just give you some of it.

And this is not based just on my experience. We have over 40 private equities in Tulsa, I think, maybe the highest in the States. And we talk a lot, and so a lot of these are experiences that we've had in developing.

And I know we've talked about-- Storm talked about the model is gone, but I'm also-- you see a lot of cyclicity going. And a lot of these rules and so on are, that I'll talk to you about, are still valid, and even if you're doing more of a type of build and develop.

Everybody's talked about these current conditions and the problems that they bring. I just mentioned the last thing the, parent-child reunion. And as I said before, in some areas, this has become a bigger issue. A lot of us knew this anyway within the industry. We were surprised that these high amounts of 30 to 40 wells per section were being touted. And like Anadarko and then the Permian.

And so now instead of 30, 40 wells per section, you're looking at 8 to 15, maybe. And so that's part of what Storm was talking about, the people looking at stock and so on for the oil and gas. They're saying, well, whoa, you've got you've changed your EUR significantly. So, and I think this is something we have to really face.

There's solutions, yeah. You do, just drill all your density wells up front, but usually you need a little more money than private equity likes to do that. There's new technologies and so on that will help with this. And so we have a lot to learn in that parent-child relationship, but that's something to keep your eye on. So

Let's talk about teams. And Dick Stoneberg talked about this a little bit. You tend to have to type of teams, and then you have different teams in between that, but a grassroots team, and that was really our team that we started out at the Council Oak. And whereas your dominated, and then you have the in play engineering dominated teams. And those actually make up most of the teams where you're looking. You're really looking at packages and so on.

And then the members-- so who do you think is the most important member on these teams? Anybody want to say?

The geologists.

The geologists. Yes, thank you. But yeah, well, I'm not sure that's right. They're all very important. Actually, the answer is the team is the most important. So, but the financier you usually have and the team builder is very important because they're the ones putting the group together in the first place. So they're very, very important.

I actually think one of the most important people are is the BD guru, and this is often an engineer. This is often-- or a land man, as you have to have somebody constantly looking for opportunities. If you don't have that, it's very hard to move. And so that is a-- BD, I think, is critical.

One, another really key individual is to have a good petrophysicist within a geology group, and because it's really funny when you look at conventional versus unconventional. In the conventional plays, you used to look broadly, and then you come down to a finite point on a structure or a strat trap, and that's what you would go after, and you'd be very concentrated with your drilling.

With resource plays, you're really starting out very, very small. You're looking at the rock, as Chris Carson was talking about. You've got to look at the rock. You've got to understand the rock. So you're starting out very small, and then you interpolate that out to a much bigger area they can drill a lot of wells. So it's a different-- it's really a different approach. You need all these.

I like a risk weighted reservoir engineer who gives you ranges as far as what you're looking at as far as your type curves and reserves. A finance guy is critical. And then if you're operating, you've got to operate the best. You've got to really be efficient with operation, and I'm sure I'm leaving some off. And so as some have already mentioned, who pays what.

So, I mean, a funny story. So we were bringing our team together, and we had one guy who was a geophysicist. And he really, a top person. And so, he wanted to be part of the team and what we're doing. And so at the end, we go, now this is how we-- we each have to invest as much. And he goes, what? I have to invest money? You mean they're not going to give me money? And I go, no. So he backed out right away. So that's an important key, is who pays.

Like I say, we were kind of broad at Council Oak, but there's some, but there's one or two that take most of that. But that's a very important conversation you have.

So business models. We've already talked about the short term makes a flip, that that's, of course Don's trying it here. We'll see how he does. And like I say, I think these things tend to be cycling, as when you stop drilling, then you don't make as many reserves, and boy, you all know the story. And so the price comes up later when your supply is down.

The mid long term buy and develop, what we've heard about, and we're going to hear from a couple of minerals and royalty people. And that's another good model.

Financial partners. These are a few. We just draw out an insurance company, but there's high net worth individuals. So some people are trying to go around private equity and go straight to some of the sources. So, which is a very difficult thing to do, and not many people have managed that yet.

So here's the main part of the talk, and I'm going through this real fast to try to catch up, but we'll-- and y'all can ask me some question later. But really, some of this seems-- I know some of this stuff's going to seem really, really obvious.

Understand market conditions. Make sure you understand early on how these private equities work. The model that Storm put together, he's going to let us have that talk. Look at that. Look at that. Look at that, kind of the history of how this works. Make sure you understand how this might work for you in the future.

Know your competition. When we got into it, we really had no idea that the private equity we had had several other teams in the area that were coming on top of us. And so you need to know that. And there's these Chinese walls in that, but do your research and make sure you know who you're competing with. And so it's a very, very important part of that.

Go to the best geology. Well, duh. Yeah, you do that. But don't-- you can kind of cheat. And the next one is, and I'll untie this, but first, wells must be good, all right? Mike Kuykendall with Felix told me that. He said, when we started, he said, whatever you do, make sure the first wells are good.

OK. Now, so, as geologist explorations, we said well, you can always do that. But I got to thinking about it, and we tried. We tried that. We weren't willing to pay up, because we you know we knew where the good ground was already. We were trying to get to the fringe of it, but we already knew where a lot of the good ground was, and we knew how much it was. And at that time, you could buy it for $5,000, $5,500 an acre. But our-- just our group wasn't necessarily willing to pay up to that price.

And, in retrospect, if you have to pay market on those first, those first areas you get, do it, do it. Make sure those first three, four, or five wells are good, because it sets the tone for the investment. Now this is one of the most important things I can tell you, is it's not necessarily that hard to find that best ground. You just gotta be willing to pay for it, and then you can go out and maybe expand into more grass roots, but that's key. And that's what I'm saying. Pay up to buy that strategic acreage.

And always block up . Sometimes we made-- we had a great technical team, and they were great at mapping, and we mapped large areas. And you could see where similar plays were, but always stay blocked up. Stay within your boundaries. Don't get too spread out. We got into our coma and we really got spread out there. Bought a lot of acreage, but we got spread out.

Look for drill call partners early is another thing if you're in this model. Private equity doesn't like to drill a lot of wells, and so look for the partners early. It would helped us if we had really started talking to drill compartments early on instead of getting to the point that we realized we just had to have that. So do that early.

Don't use expensive money to drill. In other words, that, the money that you're getting from private equity, it's really expensive money. So don't use that to drill. When you see it, it looks like a great play out here, but nobody else is in it. Don't do it. It's really tempting as a geologist to see a nice thick section of Woodford somewhere, and well, let's go out there and spend our money. Make sure you've got enough money to do that.

Do not have the highest G&A burn rate of your peers, all right? And you can figure that out, just the people around you. But don't-- you don't want you have your head sticking up above the water too high, OK? Make sure you keep that efficient.

It's tough to do, because you've got people that you've hired, that you've promise C shares and so on. And at some point, you may have too many people, but you've got to keep the G&A burn rate reasonable. Don't be the top one.

Buy producing properties when it makes sense. So now, if you're in one of these type of groups that you're buying packages anyway, often you're doing that, and what I mean by this is that when you are buying fresh leases, and a lot of land men, that's what they want to do. They really, a lot of land men don't like buying producing properties. They like to get their brokers out there, buy land, buy leases. And that, it sounds great.

You've built this up, but the three years down the road, when you start-- wind up having to chase expirations, it's bad. And so I would recommend 50% of your properties be HBP. And so that's an important part of that. Don't let ex-- and don't let expirations ever drive your drilling. Sometimes you cannot help it, but don't do that.

Do not shy away from merger. What I mean by this is sometimes the private equity wants to you to roll in another company, and you may not like their acreage, and you might think, well, there's nothing there. But look at it closely. Sometimes there's a lot of gems in that merger.

But here's the second thing is, if you go ahead and do that, you become a favorite son. And so if you're a favorite son, you're going to give better consideration over time with that private equity. So don't hesitate to do that, or at least look at it very closely.

Now I'm talking about something I don't know much about. I wish I knew more about. As the CEO, I was always watching over our operations, but operate smart. Don't assume anything about the drilling. I love the 3D that Marty had on that their team were doing.

Know that 10 foot zone. You've got to know this early. Get in and make sure you're really aware of the operations, and especially on drilling, because that's making money they right there. That can kill you if you have high DSE costs.

Frac designs. Know what's going on, what's being put in the well. And it's not that hard to find out. There is a lot. I see Halliburton's here. You can ask them to help you you. I don't if it's any Schlumbergers or Nassers here, but they'll help.

There's a lot of people to help, but also just talk to companies. We were always-- our technical a good group always shared, and that's one of the things I'd say always, always share information. To me, if you're small, to--

And so we took some core, we shared the core, and it gave back a lot to us. But like frac designs, know what the chemistry is. I'm still not sure of-- one of the best, couple of best wells in our area was drilled by a company who didn't put a lot of money into the frac. And so they actually cut out the surfactants on it. And those are the best wells, as far as our IPs is in our area.

So we talked a lot about, you've got basically, an oil wet system, and you put a surfactant on it, and you make-- you change the frac face to water-wet. So that doesn't work too good. So think about what's in the ground.

Drill out and flow back, they can easily add just a little bit of percentage to make or break you. We were dealing with a retrograde condensate, and so you really had to slow back that. And then control your cost, especially water costs. They'll kill you. Always your bottom line, and they just have a-- you got to have a good financial person. Work on that. Know what's going on. Know what the money is. And hedge when you can. Really, we have great guys' experience of hedging.

And then the final thing here is don't get greedy. There was a time in our program, and I see in other programs, where you actually have a two to one, 1 and 1/2 or two to one, and if you're this is your first time around, take it. Go ahead and make the sale if the opportunity is right. Don't wait too long, OK, because that opportunity may go.

And so timing's everything. And I know that's hard to do sometimes, to think this is so valuable. It's going to be a lot more worth later. And so a year goes by, and you're actually being off-- can get a good return, take it.

So, just conclusions. Communication is so important, communication with your private equity, communication with your team, your group. And make sure you do that. Make sure you're transparent, and it's real important.

And then embrace innovation. So we had a high technical team. We used a lot of new log suites and so on. We took core, and we did some new analysis with the core that was available. And innovation is incredibly important in this game, and especially when you're trying to figure out landings and so on.

And then teamwork. You've got to have good chemistry, as others have said. And you have to have really good teamwork, and that's important. That's it. Thank you.

Direct name or marker, entering a position. What would you say for folks who are considering going into something like this? What would you look for in somebody on your team? And what kind of communication skills, soft skills would you really look for?

Well, like I say, the model has changed. The model has changed so much now that really, you're looking more at buying and developing. And so if you're going to do that, you're going to have to develop more for long term. You're going to have to have somebody with money on your team to start out with. And so you need to associate with people that have money or whatever if you're going to try to get involved with that, because you're going to need that. To get private equity interested, you've got to have some financiers as part of your team, and that's number one. And then you just gotta look at the current model and see if you're interested in that and building that type of team.

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