Many investors were surprised at how quickly U.S. shale production recovered after the two-year global supply glut led to a slump in crude oil prices, bankrupting many shale firms, however, shale companies plodded on, and shale production has actually increased.
However, by the middle of June this year, the amount of money and equipment pouring into the shale fields began to worry many investors, leading to eight prominent hedge funds, with assets of $286 billion and substantial energy holdings, to reduce the size of their positions in 10 of the top shale firms by over $400 million.
In what appears to be an effort to continue to confound OPEC and its production cuts, perhaps, shale producers have resorted to a creative technique to get investments so they can pump even more oil. The technique, a business entity, is called drilling joint ventures, or “DrillCos,” for short.
Shale firms using DrillCos to get financing
Basically, the agreement combines cash from investors with drillable but idle land that’s already owned by the shale producers. Per the agreement, the investors are pledged to get double-digits on their returns within a few years and at the same time, shale producers don’t have to use their own money.
Without a doubt, the business of drilling is an expensive proposition and in the past two years, over $2.0 billion has been raised using drilling joint ventures in the shale industry. Analysts point out that this is just another way that shale producers and Wall Street can frustrate OPEC’s plan to reduce the flow of oil and prop-up prices.
According to Reuters on Sunday, the Energy Information Administration (EIA) estimates that with private equity showering over $20 billion on U.S. energy ventures this year, driven by shale expansion, oil production is expected to increase by 570,000 barrels per day to 9.9 million barrels per day.
No balance sheet risk
Business Insider notes that with DrillCos, it takes over the drillable land, and usually turns over 100 percent of the cash flow from oil and gas production to the investors until they earn a 15 percent return on their investment.
When returns reach 15 percent, the land is again turned over to the shale company and the investors earning drop to about 10 percent of remaining production. investors get control of the land until a double-digit rate of return in met as a sort of insurance against a default.
“It’s a type of surgical, temporary capital,” Mark Stoner, a partner at private equity fund Bayou City Energy LP, said in an interview. Bayou City committed $256 million to an Oklahoma drillcos with privately held Alta Mesa Holdings LP last year. “We get exposure to great, prolific oil basins, but don’t have to take on balance sheet risk.”