One of the most surprising discoveries of the past decade has been the amount of oil and gas we have in the United States. The shale revolution has not only turned the Bakken and Eagle Ford into black-gold mines, but it has really changed the way that U.S.-based oil and gas companies operate. As we drill into the incredible numbers we'll uncover a hidden opportunity could have investors cashing in for years to come.
It wasn't that long ago that we thought we were about to run out of gas, quite literally. At the start of the decade it was estimated that we had enough natural gas left from conventional gas wells to last us about 12 years. This belief had several companies, including Dominion Energy, building natural gas import terminals. Today, Dominion is working to convert its Cove Point LNG terminal into an export facility because we have more than enough gas to meet our needs. As the following chart shows, the impact of the shales is significant:
Source: Vanguard Natural Resources Investor Presentation (link opens a PDF).
Not only are our shale gas reserves significant, but we have tremendous potential liquid reserves as well:
Source: Vanguard Natural Resources Investor Presentation.
The problem is that those reserves will cost a substantial amount of money to develop over the next few decades. It's estimated that oil and gas companies will need to spend an average of $70 billion a year over the next 30 years to develop these plays. The total price tag is estimated to be more than $1.8 trillion. The next chart breaks down the capital requirements per play:
Source: Vanguard Natural Resources Investor Presentation.
Because of the vast amounts of capital required to develop our shale plays, many E&P companies are struggling to find ways to pay to develop the acreage they have amassed. Investors will only tolerate so much equity dilation, and using debt can have serious consequences. One look at either Chesapeake Energy (CHKA.Q) or SandRidge Energy (NYSE: SD), and you'll see what I mean. Chesapeake has seen shares outstanding rise by about 30% over the past five years, while SandRidge's share count has jumped by more than 200% over that same timeframe. In addition, both companies have taken on copious amounts of debt, all in an effort to fund production growth. Unfortunately, this hasn't worked out very well, as investors have been killed by poor recent investment returns.
The only other option to fund these capital needs is to form foreign joint ventures, which could jeopardize our dream of energy independence, or simply unload mature oil and gas assets. That last option has opened up a hidden opportunity for upstream oil and gas MLPs such as LINN Energy (LINEQ) and Vanguard Natural Resources (NASDAQ: VNR) to consolidate these mature producing properties.
Over the past decade, LINN has spent about $14 billion via 58 separate transactions to scoop up mature oil and gas reserves. The smaller Vanguard has made 18 deals totaling nearly $3 billion since 2008. What's really important to realize is that these two, as well as their industry peers, are just getting started. All signs are pointing to a sustained merger-and-acquisition boom, as there is a large inventory of mature oil and gas basins that exploration companies could tap as currency to fund production growth from shale plays.
We saw a prime example when Vanguard recently picked up $275 million in Permian Basin assets from Range Resources (RRC 2.38%). For Vanguard, these were perfect MLP assets, with proven reserves of 137 billion cubic feet equivalent and a reserve-to-production ratio of about 20 years. Even better for the gassy Vanguard is that current production is liquids-focused, with natural gas just 41% of production from these Permian assets. The assets simply didn't fit within Range's current plans to grow its production and reserves per share by double digits, so by selling the Permian assets, Range was able to unlock some capital to help fund its higher growth Marcellus and Mississippian acreage.
Because of their MLP-type structure, Vanguard and LINN are able to scoop up these producing reserves and turn them into income machines. Since 2008, Vanguard's acquisitions have fueled a 45% increase in its distribution, while LINN's deals have helped it grow its distribution by more than 80% since 2006. Both companies currently yield around 8.75% and pay (or are planning to pay) investors on a monthly basis.
The bottom line here is that exploration and production companies need a boatload of capital to develop our shale resources. One of the most palpable ways to access that capital is to sell mature production assets, and oil and gas MLPs such as LINN and Vanguard are waiting there with open arms to scoop up these assets. This hidden opportunity could deliver substantial income to investors over the years as these companies continue to grow by acquisition.
