Eight sponsor companies raised about $401 million for use within various nontraded energy programs, during 2018. That represents a year-over-year increase of 21.5 percent from $330 million raised by the sector in 2017, a commendable result considering the oil market pricing volatility observed in the fourth quarter of 2018.
Leading the sector in terms of capital raised was Mewbourne Development Corp., $116.7 million, which was followed by U.S. Energy Development Corp., $100 million, and MDS Energy, $65 million.
Of eight sponsor companies, five reported varying levels of program capital growth from 2017 to 2018 (63 percent of the sector), with each of these five companies also reporting capital growth for a second consecutive year. This trend compares favorably with what we observed from 2015-2016, in which only two of nine sponsors reported growth in program capital raising year over year.
The biggest mover in terms of raised capital in 2018 was MDS, which doubled its capital raise from $32 million in 2017 to $65 million in 2018. Also deserving of honorable mention was Mewbourne, which increased its annual raise from $78 million in 2017 to $116.7 million in 2018 (i.e., 50 percent growth year-over-year), and Montego Minerals, which increased its capital raise by about $28 million, going from no capital raised in 2017 to funding two programs this year after undergoing a planning and structuring year.
A chart of the year over year fundraising totals of the eight retail energy sponsors we cover is provided opposite (with U.S. Energy’s numbers reflecting estimated results based upon numbers that were reported in late December 2018):
The 2018 totals by strategy were:
- Drilling, $290.1 million (70%)
- Opportunity funds, $53 million (13%)
- Minerals/royalties, $57.9 million (15%)
Four 1031 programs were collectively funded by Resource Royalty and Montego Minerals in 2018. Resource Royalty acquired leased minerals primarily in the north-central Oklahoma, while Montego Minerals acquired leased minerals primarily in the Permian Basin and in east Texas. While 1031 energy capital accounted for about 15 percent of the total retail energy capital, this asset type did experience fairly significant growth in 2018.
Waveland Energy’s fundraising numbers are primarily composed of the capital raised within the closing months of Waveland Resource Partners IV. This fund raised about $80 million of retail capital from mid-year 2016 through first quarter 2018. Waveland Energy’s opportunity fund program, Waveland Resource Partners V, which opened its program late in 2018, will run its offering through Dec. 31, 2019, and is targeting $100 million in raised capital. Waveland Energy reports that 11 firms have signed selling agreements, with an additional 14 firms conducting due diligence at this time.
PERSPECTIVE REGARDING THE FUTURE
While the size of the retail energy sponsor group remained stable year-over-year (e.g., eight sponsors in 2018, eight sponsors in 2017, and nine sponsors in 2016), the capital pool increased significantly in 2018. The pace of capital growth in this sector has been steady yet arguably conservative at times over the past four years ($247 million 2015, $300 million 2016, $330 million 2017, and $401 million 2018). We believe this trend is due to severe levels of market volatility, coupled with the fact that the sector is endeavoring to regain investor trust that was lost as a result of performance failures by several companies that no longer raise capital in the retail channel. Despite the challenges, program capital increases have, in fact, been realized within the sector for three consecutive years. We believe that the overall strength of the sponsor group today, compared with what was the case 10 years ago, bodes well for this segment going into 2019 and later years, with the capitalizations and performance levels of the present group being better than that of the sector 10 years ago, with about 30 companies raising close to $1 billion in retail capital in 2008, but a substantial majority of these companies did not achieve their performance goals.
WHAT MAKES SENSE IN 2019
While pricing fundamentals remain a wildcard for 2019, there continue to be areas in the U.S. where oil and gas can be developed economically. Notwithstanding, cautious underwriting practices are key, as it is important to understand the break-evens of projects given their locations and corresponding challenges. Pro formas must factor relevant commodities pricing discounts based upon local supply/demand and available infrastructure. Additionally, special cost-related considerations, such as water disposal, sponsor/manager compensation and load, must be built into the economic underwriting models. With the support we have largely eliminated abusive turnkey structures and excessive management fees, but in 2018 our petroleum engineers identified several deals with aggressive and unobtainable assumptions.
As stated during 2018, and in respect to programs that are taking a non-operated working interest in projects, look for opportunities where the project developers have proof of concept and strategic alliances with major companies and investors. As to drilling-focused programs, we need to continue to convince most of the drilling sponsor group that capital deployment over multiple years makes sense. Those that drill over multiple years do better.
As we encouraged in 2017, look to minerals and royalties as potential opportunistic assets. This was demonstrated by a noticeable uptick in the capital raised to purchase mineral assets in 2018. Looking back at the prior performance history of a certain sponsor that dominated the royalty segment of the asset class for years, it is noteworthy that this sponsor’s portfolio of programs performed quite well in the 2000-2005 vintage years when oil was $20 to $50 per barrel and when commodities were generally on a more stable ground. Thus, there may be market upside left to capture within plays that have diverse commodities streams and good avenues to markets.
While the media continue to favor west Texas in terms of economics, remember there are core and non-core areas in all popular plays. This is another area where the value of independent project underwriting comes into play.
As we predicted a year ago, retail energy capital-
raise numbers displayed growth in 2018, and we continue to believe that 2016-2018 could be good vintage years for the group of retail sponsors that raised capital during this timeframe. A smaller but better group is reestablishing the market. While capital raise numbers have yet to reach the levels of capital raised five years ago, the “foundation for growth” exists versus what we had years ago in a promoter-infested environment.
On a final note, it is noteworthy to consider a recent article we reviewed that highlights the continuing and irresponsible use of leverage by many public and private upstream companies in the United States. The source places the debt at $280 billion, with 90 percent of the debt being attributed to shale oil producers. Using break-even prices experienced by certain of the public companies, the source estimates the upstream industry will spend $20 billion this year in covering interest payments, which accounts for 1.5 million barrels of the U.S. daily oil production. More alarming, the source estimates the production burden to pay off the leverage at 9 billion bbls, which equates roughly to what the U.S. upstream industry produced over the past 10 years. On a better note, we mention that that limited leverage is being used today by the operators that raise money for drilling from retail investors, which generally bodes well from a due diligence perspective.
Word to the wise: Do not be too quick to approve the unproven sponsor and stay disciplined on due diligence.
Underwrite, underwrite, underwrite.
Brad Updike is an attorney and director with Mick Law (www.micklawpc.com).