Congrats on-- actually, really, I think a great, great slate of speakers you
put together today. I've actually not been playing on my phone all day. I've
actually been listening. So for everyone who came to learn the nuts and bolts
about private equity and how to try to set a business up, I think this has been
a pretty good boot camp for you. So thanks for putting it together.
And when Rick called me and asked me to be a speaker, I was flattered. Then
he told me that the topic was going to be DrillCo's. And I was a little bummed
out because DrillCo's-- you have a, I think a visceral reaction one way or the
other-- it's not quite the Green New Deal reaction. But you either love it or
hate it. And so I've been kicked out of many a management presentation for pitching
this. So I might need one of Storm's coloring books to get me through this but
bear with me.
So, Mark Stone-- I'm a partner at Bayou City Energy. We're a Houston,
Texas-based private equity group. We only do upstream investments. We formally
kicked off in January of 2015, so we've been around a little over four years
now. And we're now investing out of our third fund between our three funds and
direct LP Dollar Co-investment.
We manage about $1.3 billion, and we've deployed that out through two very
distinct, yet I think, highly complementary investment strategies-- first of
which we'll obviously get into here in a second, which is DrillCo's, or what we
call drilling partnerships. And the 2nd strategy is what we call "Platform
Company Investing. And I'm going to touch on Platform Company Investing for a
second because I want, A, you to know that we do more than just DrillCo's, and,
B, I think understanding how we approach this particular type of investment
helps inform how we go about making investments in DrillCo.
So with platform companies, what we're looking to do is partner with
management teams. Typical to a lot of private equity, we want to take a control
equity position within the entity. And we want to go and find cash-flow
producing properties. We're commodity-mix agnostic, and we're really basin
We actually did do a deal in California, which I guarantee you you'll
probably never hear another guy in private equity say that. We did. It was
actually, our first deal, we exited that last November-- had a great
realization, and, frankly, I'd go back to California. There's a lot of value
there. So we're really agnostic as to where we go.
But the overarching asset quality we want is we want the asset to be
PDP-heavy and to have production. We want, as Dick Stoneburner mentioned this
morning, there's the J-curve effect in private equity, and you eliminate that
perhaps altogether if you're buying a cash-flowing property. You don't have to
keep going back to the private equity sponsor to get dollars to drill. You have
cash-flow being spun off your property on day one. And so, in a sense, you're
paying back your investment on day one. And, also, importantly to us, you can
hedge-out those cash-flows, so you can protect a lot of your investment.
So we're typically going to be buying tier-two, tier-three assets, and those
are assets that BP, others, the larger operators are leaving behind. They're
taking all their people and their money and looking after their tier-one
unconventional basins, which is the absolute right thing for them to do. But we
can come in and step in with a team that's solely focused on that asset and do
all the things that the prior operator wasn't doing-- not because they weren't
a good operator, just because it didn't move the needle for them to do a
50-barrel-a-day recompletion, or to renegotiate certain service contracts or
anything like that. But for us, we can expand margins and make a private equity
return doing that with the right team.
So that really gets us into a lot of, again, tier-two and conventional
basins. And that's great, but 99% of the brainpower and the capital in this
industry is focused on the tier-one unconventional basins. So how do we expose
our LP dollars to that part of the world? And for us, that solution is via
DrillCo's. And we think we can do it in the same risk-measured way because
we're partnering with management teams who-- or operators who have already
assembled the acreage position, they've drilled delineation wells, they've
figured out how to dispose of water, how to sell their molecules, et cetera. So
they're really at a point of development, and we can come in and provide the
dollars to get that done. So in the same way, we think that we're doing it in a
very risk-adjusted way, but we open up our LPs to really the entire breadth of
the universe at that point.
So I didn't-- or Bayou City didn't make Don's slide on the private equity
groups out there. So, I think, really, the reason we got-- or I was invited
here is because I think we've been very active in Oklahoma. Oklahoma's been a
great place for us to deploy capital. So in 2018, between our DrillCo's and
Oklahoma, and our platform company investing, we actually deployed with those
entities in aggregate at $1.1 billion drilling over 220 horizontal wells.
And at one point in time late last year, we had 14 rigs running. So we were
pretty aggressively putting dollars to work. That's actually more capital than
Newfield spent in Oklahoma last year, and it's the same amount of dollars that
Continental is budgeting for 2019 in Oklahoma. So I think we do have a very
nice presence here. We're looking to grow that. We're actually negotiating
three purchase and sale agreements right now to grow some of our positions--
those should all close on June 1. And we've also, again, we typically end up in
our platform company investing in some of the tier-two basins. We have a big
position actually in the Mississippi line, which is another thing you'll
probably never hear a private equity guy ever say.
But we're really happy. They were running two rigs. We're running three rigs
in the second half of last year. And we really like that, and we're looking to
grow that position. And if you look at what we've done since our first DrillCo
in Oklahoma back in January of 2016, we've drilled about 115 wells via
DrillCo's. And within Kingfisher County, in particular, if you went back to
2016 to today, and you considered that DrillCo entity as an operator, we'd be
the third-most active operator in Kingfisher County-- so very active there. And
I'm not sure if I'm complaining or bragging, but we did pay about $30 million
in production taxes last year to the state of Oklahoma. So, again-- big
So what is a DrillCo? There's a million different varieties. Everyone cuts
and slices them a little bit differently. But in typical, this box to the right
is the usual structure. So a financial partner and an operator come together
and create what's called a Joint Development Agreement, or JDA, which lays out
the who, what, when, where, why, how you go about prosecuting a development
program on a specific amount of wells.
Those that the financial partner brings the capital-- typically, anywhere
from 80% to 100% of the capital. The operator brings the know-how and the locations.
The locations get drilled. Cash-flows go through a waterfall. The operator
receives a promote-- typically, up to about 20%. And once an IRR hurdle is hit,
typically, mid-teens IRR hurdle-- there's what's called a "reversion"
where the bulk of the interest goes from the financial partner back to the
operator. So instead of being a 10% to 20% working-interest owner at the get-go
through the promote, once the IRR hurdle is hit, the operator can be back to
90%-plus of the program. So it's a pretty effective structure for an operator
to get wells drilled. And this is, typically, an off-balance sheet structure.
So it's not-- it doesn't show up on the balance sheet as debt or anything like
Again, I said there's a lot of different ways to do this. I'd point out a
couple of the unique things, or perhaps unique things to Bayou City in terms of
how we approach this. One, we will be wellbore only, which I think not a lot of
people are willing to do that. So we live and die by how each wellbore
produces. We don't-- it's not a carte blanche dilution of the operator's
footprint in the basin. We're not taking working interest in a drilling spacing
unit. We're not getting interest in PUDs. We're getting nothing outside of that
wellbore. So there's really absolutely no bail-out zones for us. So we have to
have a high degree of confidence in the drilling program and the operator's
capabilities when we set into-- when we set the Joint Development Agreement
plan into motion.
That the quid pro quo there that we look to do is put in place-- AFE caps,
so we will look to fund 100% of the program. We'll lay out all the AFEs, and
we'll agree that we'll fund 100% of that amount. Some wells will be over. Some
wells will be over, and at the end of the day, the concept is, we'll fund 100%
of the program. But this does insulate us from train wreck after train wreck
after train wreck with the operator. And because we're wellbore only, it's
protection that we need.
Also, unique to us is we can be small, but scalable is how we put it. So
we're perfectly fine starting off at a 15-well, 20-well program. We don't need
hundreds of locations or a $500 million bogey to hit with an operator. We can
start small, and I think that that should resonate with operators. We're happy
to start big, but I think starting small in this environment where the
president can wake up, send out a tweet that moves the oil markets one way or
the other, the power goes out in Venezuela, there's a whole list of things that
can happen. I think the operator wants to maintain as much optionality in terms
of their drilling queue as they can. So by piecemealing in locations over time,
I think is a pretty friendly way to get this structured.
Obviously, we're happy if the operator, for whatever reason, wants to start
with 200-- we're happy to start with 200 locations. But, again, we can be
smaller than most of our peers. And we do view this as a true partnership. And
we're not trying to structure this like it's a MES product or a credit product.
So there's no what we call unilateral off-ramps. If the first set of wells
don't turn out like the type curve we underwrote to says they will, we're not
going to just walk away from the program.
We understand that entering into this is an important part of putting
together your development program-- an important part of putting together your
budget. You're going out and getting long-term service contracts, marketing
contracts, et cetera. So we will agree to stick it through with you. Obviously,
I think if we both sit across from the table from each other, and we agree that
it doesn't make sense to do it anymore, we're happy pushing the pause button or
stopping altogether. But there's no speed bumps that we insert into the
document where prices hit X, or if type curve is Y minus a percent where we can
walk away. Again, we think that that's a pretty friendly approach there.
So in terms of what we look for, it's really pretty simple. We look to
partner with an operator who has drilled wells, who has demonstrated that they
can drill wells to AFE, and they can drill wells over time within a relevant
sample size-- they can hit type curve. And we're not looking to be dollars that
help you come up with a learning curve.
By the time we want to partner with you, the operator's figured out what's
the right completion design. Where do I want to lay my lateral? And we're not
training wheels trying to get the operator to a point where they can hit Eject.
We want to make sure that it's a bona fide operator who has a track record. For
the wells to hit reversion, you really need wells that are 30% plus IRR. That
was harder to do at $55 oil. Today, at 62 or 63, it starts to-- the map starts
to light up a little bit more. So you typically want that because I think both
parties are incentivized to see the reversion occur.
On number 4, we view the presence, or we expect that the presence of a
DrillCo is something that should expand margins and drive down costs for the
operator in general-- so adding that incremental rig, or locking up a service
provider for a 20-well program should, at the margin, help you with your cost.
And so we view that as helpful within the program as we deploy dollars and,
again, helps both sides.
On the 5th point here, obviously, we'd like to expand, so we want to make
sure that there is inventory. If we agree we want to expand that there's
something we can do there. And on 6 and 7, this is an IRR-driven product, so
that means that you don't want to have chronic delays or systematic delays
built into the development program. You want to be able to drill a well, get
permits, and get gathering and flow-lines set up so you can get it to sales as
quick as possible.
Some of the-- DrillCo's two, three years ago we were really a stigma
product. If you were an operator looking for one of these, that meant something
probably pretty bad was going on in terms of your finances. I think that's
fundamentally changed starting in 2017. Seeing EOG, Diamondback, and other
really blue-chip operators start to embrace this strategy. And the reasons for that,
I think are pretty apparent. But the upside is ultimately going to go to the
operator, at least within the Bayou City structure.
So promoted cash-flow, PUDs, the HBP acreage, et cetera, the efficiencies
that you get through an expanded program-- that all goes to the operator. This
is something that is off-balance sheet and nonrecourse, so it's credited
creative to the operator. And you're creating value. You're creating reserves.
You're creating cash-flow out of otherwise long-dated, dormant inventory. And,
again, that's something that, as the wells come on-line, you can hedge volumes.
You can book reserves. If you think about what the curve looks like once
reversion hits, you're going to pop up from that 10% to 90% or whatever that
number is. And so the DrillCo's-- once you revert, it synthetically flattens
your decline curve and smooths out your cash-flow. And in a world where as
everyone's mentioned today-- it's all about dividends. It's all about creating
sustainable cash-flow. I think that's a pretty appealing piece of the structure
And then lastly, there's the ability to refocus capital. A lot of operators
are multi-basin-- doesn't make sense to continually drill your tier-two stuff
just because you have MVCs or drilling commitments. So we can free up your
capital, so you drill all tier-one stuff. And we're happy to come drill your
tier-two stuff as long as you hit that 30%-ish IRR.
And then lastly, it's not on here, but DrillCo's really worked well in
Oklahoma because you can use it as a really offensive weapon to go out and HBP
and force-pool a lot of acreage, which the operators we partnered with have
done this pretty well. So, Alta Mesa-- we closed this in January 2016-- it
actually took us about 35 days to negotiate and put the JDA in place, which is
faster than I think most people even get to in LLY. So we were able to put
together a pretty friendly playbook. And we funded the first well in January of
2016 when prices were, I think, $27.
So, again, we're not-- we don't create outs for ourself. We'll do what we
say we're going to do. And Alta Mesa has been textbook in how they've used
this. They've been able to HBP a lot of acreage, and they've expanded the
number of tranches within the DrillCo handful of times now. So we've been happy
with that exposure.
And then lastly, with respect to Oklahoma, we've also created a partnership
with Chaparral in Canadian County and in Garfield County. We had the concept
for Chaparral is they had a clean balance sheet. They wanted to accelerate
development as much as possible and delineate Garfield County, which I think
not many people draw on the map of the stack. So they wanted to create a
And so we put 17 wells in Canadian County and 13 wells in Garfield County
and kind of married the way we viewed risk around that to come up with the
structure there on the right. And we've now funded all 30 wells. We started
this program in September of '17, so pretty quickly got through it. And with
that, I guess, stop for questions or go sit down.
Thanks a lot, Mark. Questions? Right here.
So thank you, Mark, we're still in transition.
It seems like there should be another arrow of what happens when you don't
hit the IRR, and what happens when things don't go right?
When things don't go right, we never get to that IRR box. And so, in this
example, we'd be 85% working interest owner in a lot of wells that were poor
performers. And, ultimately, there's no reversion that happens. But you know
there's nothing beyond that. There's no acreage collateralization or hooks into
existing PDP or other treasures within Chaparral that we have recourse to.
Any other questions?
Question then about since a lot of these happend on the tier-two and
tier-three acreage, and in light of just unconventional service company
intensive tech work, have you guys noticed any service-quality related issues
with the service companies? Because a lot of those tend to be devoted to the
larger customers on tier-one acreage. And we found that an AFE max really
mitigates that for you. Do you see AFE for lats above the AFE max?
I think the fact that we can cobble together-- a lot of times, you're
partnering with someone who episodically has drilled-- has never had a fulsome
development program of multiple rigs. So by being able to put out that two-year
drilling commitment or rig line, I think that that helps get you the better
quality service providers. And, yeah, we really haven't seen-- at least to my
knowledge-- that any deterioration here versus there on DrillCo wells based on what
I'd call poor service providers, or B service teams.
How do you control AFEs when they start to overrun?
How do we control AFEs?
Yeah, when you get AFE overruns. Do you step in and tank? You start setting
limits. You start tightening the strings. What do you do?
We set limits. So we'll fund 100% of what we all sit across the table and
agree that the well will cost. And the operator will take overages.
Overruns are on the operator?
OK. Thank you.
You know there's never any overruns. You know that.
If there ever was an overrun.