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A Gusher Of Cash For Domestic Drilling


While the rest of the country frets over surging energy prices, a small but growing group of businesses is fueling a boom of sorts in the U.S. oil patch. Dozens of new exploration and production companies, backed by billions of dollars in private equity, are forming to take advantage of flush times. While such players have sprung up in past cycles, "it will be much more pronounced" this time around because investors are confident that oil and gas prices will remain high, predicts energy analyst John E. Olson of Sanders Morris Harris Group Inc., a Houston-based brokerage.

The new money is increasingly focused on drilling for new pockets of natural gas and oil, not simply acquiring and exploiting mature properties left behind by the majors and the large independents, which are chasing bigger opportunities overseas. "The United States oil-and-gas story isn't one about BP Amoco (BP), Exxon (XOM), or Chevron (CVX) anymore," says Kenneth A. Hersh, managing partner at Natural Gas Partners, a big private-equity firm in Irving, Tex. "There are many private companies who are doing exciting things, who are making things happen."

These explora-tion-and-production upstarts -- mostly run by energy-industry veterans -- will brighten an otherwise dismal picture for domestic production of oil and natural gas. The Energy Dept. this year predicted that onshore oil production in the Lower 48 states would fall 1.8% a year through 2025, while natural-gas production in the same area would rise 0.7% a year over the same period. A burst of fresh investment should improve both figures, at least incrementally.

SAVVIER STARTUPS

That said, the extra output won't be enough to yank energy prices back to earth. In fact, barring a big slump in demand, "we're hard-pressed to see anything...that will bring down prices a lot," says Arthur L. Smith, CEO of energy consultancy John S. Herold Inc.

That's just fine with investors. Gary R. Petersen, a principal at EnCap Investments LP, figures private-equity firms such as his with money from insurance companies, universities, and other institutional investors have at least $5 billion earmarked for North American exploration and production companies, double the level of three years ago. More broadly, Cameron O. Smith, senior managing director of Cosco Capital Management LLC, estimates at least $15 billion to $20 billion in private capital is available for investments in North American energy companies of all sorts -- from E&P to coal to services -- about double the amount of a decade ago.

That's not even counting those who are starting up by tapping friends and family. Joseph W. Foran recently launched his second energy company, Matador Resources Co., with $50 million from wealthy friends and neighbors. He started his last one 11 years ago with $270,000 and sold it last summer for $388 million.

The new crop of startups is savvier than those of the past, some observers contend. They're typically run by executives age 35 to 60 who have already managed through booms and busts, says Herold's Smith, who counts at least two dozen private E&P companies formed in the past several years. "The people getting the capital are much more disciplined," agrees Randy A. Foutch, founder and CEO of Latigo Petroleum Inc. in Tulsa. He started Latigo, his third energy venture, two years ago with $300 million in equity from Warburg Pincus LLC and JPMorgan Partners.

Another difference: In the case of natural gas, the drilling is often in unconventional reservoirs that were previously ignored, such as tightly packed sands and coal seams containing gas in the Rocky Mountains, Texas, Oklahoma, and other areas. The risk is fairly low because geologists know gas is there, even if it's hard to extract. And investors aren't spending much on high-stakes exploration in unknown territory.

The influx of money has helped to boost the number of wildcat exploration wells drilled in the U.S. to 1,525 last year, up from 1,252 when prices collapsed in 1999, says Philip H. "Pete" Stark, vice-president for industry relations at consulting firm IHS Energy Group. He figures that number could hit 1,875 this year, the most since 1990, with independents drilling the lion's share.

More players and more money mean more competition for acquisitions, people, services, and supplies. So is the industry setting itself up for sky-high costs and another bust? Executives and analysts insist their costs are under control and that the short supply of talent will limit activity in any case.

More important, the experienced players remain cautious and cost-conscious because of the pain they've suffered in past downturns. Jeff Johnson, CEO of Cano Petroleum Inc., which went public in June, figures his company could make money on its Oklahoma oil fields even if prices fell to $25 a barrel. That's half where they stand now but still good compared with previous busts, when oil fell as low as $10 a barrel. "We believe high oil prices are here to stay," says Johnson. He has a lot of smart money betting with him.

By Wendy Zellner in Dallas


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