Value Planning for Entrepreneurs in the Oil Patch: Ignore Allure of $45 Pricing, Hopes for $70 in 2017

Entrepreneurs in the oil patch have long monitored the daily movements in WTI spot price as a method for gauging future business prospects. Blood is in the streets. Upstream operators, midstream players, master limited partnerships, service companies, are all scrambling for answers. What will the Saudis do? Is the Chinese economy heading towards deep recession? Will prices rise above $70 in 2017? These are viable questions, but there is one fundamental question that should be addressed above all: How can I best regain value in my business?

Gone are the days of $100 oil; we may never see a sustained period of time at that price level, ever again. The key word there is ‘sustained.’ I’ve come across several business owners over the past year that have taken solace in the notion that the pendulum will violently swing back to $100 just as it swung down to $26. This idea is fool’s gold. Here’s why: even if we do see $100 in the future, it will be the result of an unforeseen supply disruption that will be short lived. Drilling budgets will quickly mobilize, the floodgates of private equity will open, and shale will fill the supply gap even faster than it did from 2010-2014.

The U.S. shale boom was explosive, adding over 3 million barrels per day in just four years and resulting in domestic production levels that had not been seen in decades. This dramatic jump occurred in a relatively short timeframe. With the technology now in hand and rapidly improving, markets will rebalance even quicker should we breach $100 pricing; hence, the stay above $100 will be short lived and smart buyers will simply wait for the inevitable decline. Furthermore, potential suitors for your business will reference the recent collapse as a solid case against a significant rise in the valuation of your firm. Volatility has made you great cash in the good times, but it is a two-headed monster, rearing its ugly head when it takes a bite out of your valuation. An exit window above a $100 price point will be difficult, unless the business holds impressive technology, sticky clientele, or other value-driven attributes.

It doesn’t take a wild imagination to come to these conclusions. Sure, Harold Hamm, T. Boone Pickens, and other billionaires will chime in with commentary that prices will be at $80 by December 2016. If you own a small business, you are better off ignoring these powerful commentators that have a vested interest in trading unimaginable sums of money. The pragmatic approach is founded in basic economics. This playbook is being drafted and executed best by Schlumberger. Look no further than Schlumberger’s $12.7 billion acquisition of Cameron and global alliance with Packers Plus. With deals like these, the world’s leading oilfield service company is increasing scope of services, broadening its customer base, aggressively pursuing synergistic growth, and increasing market share.

What should the small players do?

1. Recognize that Saudi Arabia is playing the same strategy as Schlumberger, with a different approach. In the World Series of Oil Poker, the Saudis have decided to take aim at market share. The kingdom will liquidate chips by accessing public markets in an IPO of five percent of Saudi Aramco. This cash ($100-125 billion) will be used to stabilize the kingdom’s balance sheet and ramp up production beyond 11-12 million BOPD; gobbling up market share and filling the pending supply gap (despite claims of diversification). They have announced an interest in pumping 20 million barrels per day; consider this a warning shot.
2. If you can’t pay in cash, don’t buy it. This should be your mantra for the remainder of your company’s existence. Continue to trim the fat. Layoffs are tough, but necessary. Get to a point in your business where the balance sheet is strong and the company is able to prove a long-term business model.
3. Use other people’s money. Private equity funds and debt providers are patiently circling the bloodbath. You may learn of competitors that are going bankrupt or barely keeping the doors open. If an acquisition opportunity presents itself, bite the bullet and partner with private equity. Sure, these groups will take an equity position in your company, but they provide a platform to grow without putting a significant amount of your own capital at risk.
4. Explore mergers or joint ventures. It can be a tough pill to swallow, but desperate times call for creative thinking and bridge building. Identify competitors or others in the space that present the opportunity for vertical integration between business models or other synergies. As previously mentioned, the larger players in oil and gas have been pursuing the mega-mergers for the past few years. In order to compete with a rapidly consolidating industry, economies of scale must be achieved; if not through private equity backing, try finding common ground with industry peers. Also, keep in mind that the entrepreneur has access to such deals well in advance of private equity funds due to their established relationships and position on the front lines of the oil patch.

The industry pain is real, but business owners that have held on this long can recapture what has been lost through careful planning and exploiting long-established industry relationships. Pegging hopes on WTI spot price recovery is a dangerous game. The real winners will identify under-the-radar, cost effective strategies focused on increased market share as the industry continues to consolidate through bankruptcies, mega mergers, and large private equity-backed deals.

Mike Umbro is the founder and Principal of FieldView Capital Advisors, LLC, which offers services specific to mergers, acquisitions and divestitures. A well-seasoned professional, Mr. Umbro brings to clients experience and expertise in financial services and all aspects of investment banking.