Over the past several years there has been significant price volatility for both oil and natural gas. As illustrated in exhibit 1, from the beginning of 2016 through the end of the first quarter 2018 spot prices for Henry Hub natural gas ranged from a low of $1.57 to a high of $5.71 per million British thermal unit (BTU) and Cushing OK WTI crude oil ranged from a low of $28.14 to a high of $65.32 per barrel.1
Exhibit 1: Natural gas and oil price volatility (2016 – Q1 2018)
Source: US Energy Information Agency
Many factors have impacted both the spot prices and the corresponding forward curves for natural gas and oil. In our opinion, this volatility continues to produce a number of favorable investment opportunities for the Private Equity Energy strategy that seeks to deploy capital on a long-term basis (typically 7 to 10 years) via management teams that aim to maximize internal rate of returns (IRRs) across one or more energy cycles (typically 3 to 5 years).
The Private Equity Energy strategy does not attempt to time the market, rather it is focused on deploying capital into lower risk proved developed producing (PDP) upstream US onshore oil and natural gas assets. Central to the strategy is risk management hedging throughout the life of each investment. More specifically, the purpose of the risk management hedging is to lock in acquisition economics to the extent possible (with rolling hedges), thereby producing more stabilized cash flows than would be generated with unhedged oil and natural gas investments.
It is important to recognize within the Private Equity Energy strategy not all PDP is hedged—nor is it possible to hedge the reversionary value of specific investments. By appropriately managing and improving the oil and or natural gas production, specific management teams are able to achieve asymmetrical returns from this relatively lower risk strategy. The strategy does not involve exploration, but rather focuses on exploitation of proven oil and natural gas reserves.
In addition, our strategy does not utilize leverage at the portfolio level, and to the extent that underlying management teams utilize debt the leverage is relatively low. The combination of more stable cash flows from risk management hedging along with low leverage provide our management teams the ability to focus their attention on improving the underlying performance of the acquired oil and natural gas assets with the goal of maximizing specific investment IRRs.
Investment activity (2016-2017)
Many of the investments Aegon Real Assets has made over the past several years have been the result of sellers not having appropriate risk management hedging and or sellers over-leveraging their PDP oil and natural gas properties. As a result, specific management teams have been able to acquire high quality PDP oil and natural gas properties on favorable investment terms from over-leveraged/under-hedged sellers that are in bankruptcy or are involved in other forms of forced financial restructuring.
As illustrated in exhibit 2, during the past two years the Aegon Real Assets Energy group has deployed over $200 million of new equity capital into oil and natural gas investments. Aegon Real Assets has varying percentage ownership interests in specific oil and natural gas properties through limited partnership interests via management teams serving as general partners. This investment ownership structure serves to provide Aegon Real Assets both asset specific and management team diversification. Risk management and diversification are central to Aegon Real Assets private equity investment strategy.
Management Team One – Acquired a group of natural gas upstream and associated midstream assets in the Haynesvillle formation of Louisiana and Texas representing 2,000-plus wells with over 250 billion cubic feet equivalent (bcfe) of PDP reserves along with 270,000 acres and 380 miles of midstream and treatment facilities.
Management Team Two – Obtained two separate investments in oil production asset portfolios in the Bakken formation of North Dakota. The first investment was in 80-plus oil wells with over 1,700 thousand barrel of oil equivalents (MBOE) of PDP, more than 5,000 MBOE of net total proved reserves and over 11,000 net acres held by existing production. The second investment was in 300-plus oil wells with net production of over 1,500 barrels of oil per day (bopd) and over 2 million cubic feet per day (mmcfd) and over 14,000 acres held by existing production.
Management Team Three – Acquired several separate natural gas portfolios. The first investment was in 500-plus wells with over 2,500 mcfpd and over 60,000 net acres located in Colorado. The second investment was in 1,000-plus wells primarily natural gas representing reserves of 24 bcfe, 149,000 net acres held by production and associated gathering systems located in Oklahoma. The third investment included 150-plus wells (consisting of 67% natural gas and 33% oil and natural gas liquids) with over 6,000 net acres held by production in Oklahoma.
Management Team Four – Made two investments. The first investment was in 700-plus wells and over 50,000 acres in the Vernon Field of northern Louisiana and the Permian Basin of West Texas (note that the majority of this investment was in Vernon Field). The second investment was primarily in natural gas-related assets located in the Eagle Ford formation of Texas represented by 90-plus wells producing 33 mmcfd with proved reserves of 289 bcfe and over 50,000 acres.
Exhibit 2: Over $200 million in new equity capital deployed by Aegon Real Assets Energy group (2016-2017)2
Investment activity year-to-date
With regard to 2018 investment activity, as of the end of March 2018, Aegon Real Assets remains very active in new capital commitments/deployment via management teams. New investments include a recent closing involving 1,800-plus natural gas wells and over 100,000 acres in the Barnett formation of Texas, which was acquired in January of 2018, as well as two other investments. The first investment, is located in east Texas with over 140 wells representing production of 1,857 boepd with an approximate split of 51% oil and 49% natural gas liquids along with 47,000 acres. The second investment, which recently closed, is located in Oklahoma and includes 65 wells representing 3,009 boed. We have summarized this opportunity in a case study to provide an example of contemporary metrics regarding acquisition economics.
In conclusion, we believe that market conditions remain favorable. We continue to actively evaluate, commit and deploy capital via management teams based on the same focused investment strategy that has been utilized since 2003.
Case study – Acquisition economics of a recent investment in Oklahoma
- The seller acquired the asset in 2013 for $180-plus million utilizing high levels of leverage and, in our opinion, did not sufficiently utilize risk management hedging. Significant price volatility during the seller's holding period combined with a lack of risk management hedging and high amounts of debt, led to substantial violations of loan covenants resulting in the lender taking over financial control that required the sale of the subject asset.
- The seller engaged an investment banking firm that received a purchase offer at $140 million with the lender and seller agreeing to close prior to year-end 2017. However the buyer did not have sufficient capital to complete the closing. The management team which Aegon Real Assets made a capital commitment served as a back-up buyer having already completed due diligence but elected to not submit a bid because of the high price the original buyer had negotiated.
- Ultimately, the management team was able to acquire the asset at a net purchase price of slightly above $106 million. The management team based their acquisition economics on January 17, 2018 oil and natural gas forward curves that indicated a range of base case potential IRRs from 16% to 29% and a multiple on invested capital (MOIC) of 1.6x to 2.7x depending on the assumed year of exit for this investment.
1Source: US Energy Information Administration
2Source: Aegon Real Assets US, December 31, 2017
Aegon USA Realty Advisors, LLC (Aegon Real Assets US), an indirect wholly owned subsidiary of Aegon N.V., is a US-based investment adviser registered with the Securities and Exchange Commission (SEC) and part of Aegon Asset Management, the global investment management brand of Aegon Group. This material is intended only for sophisticated and experienced investors. The information included in this document should not be construed as investment advice regarding any security, a recommendation for the purchase or sale of any security, or an oﬀer to sell or solicitation of an oﬀer to purchase any security. Such oﬀer or solicitation may be made only upon delivery and an investor's consideration of the governing fund documents which discuss in detail all material aspects of the investment opportunity, including pertinent risk factors. The enclosed information has been developed internally and/or obtained from sources believed to be reliable; however, Aegon Real Assets US does not guarantee the accuracy, adequacy, or completeness of such information. This material contains general information only on investment matters; it should not be considered as a comprehensive statement on any matter and should not be relied on as such. The information it contains does not take into account any investor's investment objectives, particular needs or financial situation. The value of any investment may ﬂuctuate. Results achieved in the past are no guarantee of future results. Proposed terms are a summary in nature and are not complete. These terms may change materially at any time. This material contains current opinions of the manager and such opinions are subject to change without notice. Aegon Real Assets is under no obligation, expressed or implied, to update the material contained herein. If there is any conﬂict between the enclosed information and Aegon Real Assets US' Form ADV, the Form ADV controls. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to you. This document includes projections or other forward-looking statements regarding future events, targets, intentions or expectations. Due to various risks and uncertainties, actual events or results may diﬀer materially from those reﬂected or contemplated in such forward-looking statements. There is no guarantee that projected returns or risk assumptions will be realized or that an investment strategy will be successful. No representation, warranty or undertaking is made as to the reasonableness of the assumptions made herein or that all assumptions made herein have been stated. No part of this material may be reproduced in any form, or referred to in any other publication, without express written consent of Aegon Real Assets US, 4333 Edgewood Rd NE, Cedar Rapids, IA 52499. ©2018 Aegon Real Assets US AdTrax: 2089229.1 Exp Date: 4/30/2019.