Oil & Gas Investment Banking

7/16/13
Gmail - [New post] Oil & Gas Investment Banking: More Money Than Big Oil and Big Banking Combined?
canberk dayan <canberkdayan@gmail.com>
[New post] Oil & Gas Investment Banking: More Money Than Big Oil and Big
Banking Combined?
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Mergers & Inquisitions <donotreply@wordpress.com>
To: canberk.dayan@gmail.com
Tue, Jul 16, 2013 at 1:10 AM
New post on Mergers & Inquisitions
Oil & Gas Investment Banking: More Money Than

Big Oil and Big Banking Combined?
by M&I - Luis
If theres one coverage

group thats even more
desirable than metals and
mining, it just might be oil &
gas investment banking.
Not only do you see some
of the biggest deals with
the worlds largest
companies, but you also
learn new accounting
techniques, valuation
methodologies, and maybe
even something about
petroleum engineering.
Everything within the
natural resources group
metals/mining, oil & gas,
and power and utilities is
like a cross between industrials and commodities, and you see that most of all with oil &
gas where some sectors (upstream) are commodity plays and others (oilfield services)
are much closer to normal companies.
We have a sector specialist onboard today whos going to break it down and explain
everything to you.
Heres a quick geological survey of the land ahead, before we dig in and start drilling
wells:
https://mail.google.com/mail/u/0/?ui=2&ik=fb623ddf21&view=pt&search=inbox&th=13fe5e38118dc49a
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Who gets into oil & gas investment banking and how to maximize your chances of
breaking in
Sector drivers and what to look for when analyzing an oil & gas company
Valuation, from NAV to EBITDAX and everything in between
The top boutiques and other banks in oil and gas coverage
Where you go after the sun sets and you decide to look for more lucrative oil fields
From Petroleum Engineering to Financial Engineering
Q: A lot of analysts and associates get placed into their respective groups by
happenstance, luck, or just good ol networking. How is your story different?
A: I actually studied petroleum engineering in college, which focuses on calculating the
availability of resources.
Nowadays, students tackle broader energy allocation studies, including utilities / power
generation and alternative energy. A lot of people here in New York work in finance, but
as youve said before, if we were all in Texas, we would all talk about how were in oil and
gas. :-)
[N.B.: A friend of mine did time in consumer investment banking, worked at a retail
company, and then moved into oil and gas.]
I started off wanting to be a petroleum engineer, and had a couple of internships working
in laboratories and then in offices.
Working at a normal company in this industry is very different from working at a bank
for instance, if you were doing finance at a place such as ChevronTexaco, your work
would be more focused on a narrow line of activity at that firm, though youd still need
solid attention to detail.
Q: And so you wanted to move into banking to get a broader view of the sector?
A: Exactly. At an investment bank, your work is much broader, macro-oriented, and you
might even say you have a birds eye view of things.
This is one reason why you see [petroleum] engineers trying to get into investment
banking following their internships in industry. Another reason (drum roll) is the goldplated exit opportunity.
Even with only a 3-month internship, people look at you differently and expect a little
more from you.
When it came time to apply for investment banks, I contacted alumni, cold emailed
boutiques, and reached out via LinkedIn to anyone I had something in common with. The
bankers saw I already had an energy background, so the conversation was pretty easy
from there.
Unlike other sectors, where you can get in without much industry knowledge, sector
expertise is highly valued in oil & gas. Theres so much jargon and so much to know
that you really need some type of exposure beforehand.
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If you didn't study natural resources in your major, at least take a class. I know some
people get placed randomly, but you definitely want to do the pre-season training
ahead of time if you can.
Back in 2003, there was a booklet called Economics of the Natural World, by the US
Academic Decathlon. Reading something like this would be a quick starting point heres
a chapter on natural resources microeconomics.
Surveying the Landscape: Successful Exploration Expenses & Intangible
Drilling Costs
Q: So how is your group divided? What are the different segments?
A: Much like other groups, the oil and gas sector can be viewed in different ways.
The two most common methods are by stage and company size. The latter is easier to
explain, so well start there:
Super Majors: These are the largest oil firms in the world. At the time of this article, the
list includes British Petroleum, ChevronTexaco, ExxonMobil, Royal Dutch Shell, and Total
SA. These companies do everything, from finding oil and gas to transporting it to
refining it.
Before you get really impressed, keep in mind this list excludes state owned companies.
If you were to include those players as well, the number one contender would be Saudi
Aramco, with over $1 billion per day in revenue and sometimes estimated as being
worth $10 trillion USD (not a typo). Several other state-owned Russian / Chinese /
Middle Eastern companies are on that list as well.
Master Limited Partnerships (MLP): These companies are similar to Real Estate
Investment Trusts (REITs), in that they are tax-efficient entities that derive their income
from one source: in the case of an MLP, that source is pipeline revenue earned by
transporting oil and gas rather than exploring or refining it.
Companies include: Magellan Midstream Partners LP, Energy Transfer Equity LP, and
Plains All American Pipeline LP.
For more information on MLPs, please see this primer by Wachovia.
Companies smaller than super majors and companies which are not MLPs tend to fall
into one or more of the categories below:
Integrated Companies: Not quite the largest, but still sizable firms. These companies
operate across multiple stages, which is a little more complicated than dividing the world
by company size (Companies include: Petrobras, China Petroleum & Chemical, and
Statoil).
Upstream (Exploration & Production, or E&P): These companies explore sites to find
oil and gas, and then develop and produce what they find (Companies include:
Transocean, Diamond Offshore Drilling, and Atwood Oceanics).
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Midstream: Storage and transportation these companies often do take the form of the
MLPs discussed above, but tend to be smaller and more focused on only these activities.
Downstream: Refining, logistics, and marketing. By marketing, I mean the retail
operation (at the gas station) or even in the store (other petroleum products)
(Companies include: Phillips 66, Marathon Oil, and Hess Corp.).
Other: Outside of these categories, there are companies in sectors such as oilfield
services (think: Halliburton) that fall under the oil & gas classification but which really
provide infrastructure or services to energy companies.
If you want to know more about how the sector works, please see this primer by
Investopedia.
Q: Great, so what moves the market for oil and gas?
A: On a macro level, economic conditions, and in particular, geopolitical events (national,
regional, and local) make an impact on the market.
These (broad) factors influence both demand and supply.
On the demand side, you see economic growth, debt grade improvements or declines,
population growth, civil unrest, and political instability as factors.
Suppose you observe massive growth in emerging markets such as China and India; this
economic growth would be the biggest demand driver when your GDP increases almost
20x in real terms, inevitably you will use more energy.
You can add seasonality as a driver as well: when things get cold, you tend to use more
energy...
Supply side, you have OPEC (Organization of Petroleum Exporting Countries)
decisions, access to financing, and discoveries of new deposits or even updated
findings.
From a government standpoint, the factors include access limitations (where can we go
dig?), the type of drilling a company can undertake, and government sponsorship of
alternative energy.
You can add wars, sanctions (Iran), production/refining capacity, natural disasters, and
technological advancements (fracking and horizontal drilling) to this list as well.
Upstream: On a micro level, the factors include the outcome of individual drilling
projects (how lucrative they are), operational outages, strikes, asset sales, regulatory
changes (tax breaks anyone?), and prices under sharing agreements.
Sometimes youll see an oil company split the costs of a dig with another firm or do a joint
venture. You frequently see this with government-owned companies a private firm will
be brought in to share its expertise (think: Russia and Exxon Mobil with their arctic shelf
drilling plan).
Downstream: Margins are determined by what the company pays for in terms of raw
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materials and the price of the output (set by the market).

This latter point is established by a number of factors. According to ExxonMobil, these
factors include: global and regional supply/demand balances, inventory levels, refinery
operations, import/export balances, currency fluctuations, seasonal demand, weather
and political climate.
Q: And what are some of the indicators that oil & gas professionals look at?
A: For starters, youve got the OPEC basket price that is looked at globally.
Without a doubt, OPEC has a strong influence over the supply of oil. Domestically, you
look at West Texas Intermediate and abroad, you also look at Brent (named after a kind
of goose).
Finding and Discovering the Technical Depths
Q: Since oil & gas is such a specialized sector, would you mind sharing a few
pitch books before we move into the technical details?
I think its easier to understand if you can see some of these metrics and
methodologies.
A: Not at all, please take a look at these:
Pinnacle Gas Resources by FBR Capital Markets [fka: Friedman, Billings, Ramsey &
Co.]
Hiland Holdings by Barclays Capital
Exxon Mobil / XTO Energy by Barclays Capital
Chevron / Texaco by Credit Suisse (search for the text conducted three valuation
analyses)
Q: Great. So with those examples in mind, what are the more common valuation
methodologies and multiples?
A: This gets complicated because it depends on the specific area that you are working
in (ex: integrated, upstream, midstream, and downstream), but let me summarize it:
Upstream (E&P)
You tend to use Production and Reserves-based multiples here, such as Enterprise
Value / Proved Reserves and Enterprise Value / Daily Production, because when
analyzing energy companies youre always asking, How much am I paying for each unit
of energy in the ground and/or production capacity?
EBITDAX is a variation on the traditional EBITDA metric, and it exists because some oil &
gas companies expense unsuccessful exploration and others capitalize it so it
normalizes and makes it possible to compare companies that follow different standards,
similar to what EBITDAR does for companies that own vs. rent buildings (or airplanes).
Youll see lots of Reserve and Production-related metrics such as the Reserve Life Ratio
(Reserves / Production), % Oil vs. % Gas, and even Key Geographies shown along with
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these multiples.
The Net Asset Value (NAV) methodology is also very important and is a twist on the
traditional DCF; unlike a DCF, where you assume infinite growth into the future, with a
NAV model you assume that a companys reserves get depleted far into the future and
that revenue and profit go to $0, perhaps after a few years of growth initially.
So you project cash flows (production * commodity prices expenses) until the reserves
run out, discount and add them up, and then factor in the value of other business
segments, undeveloped acreage, and so on.
This can get infinitely complicated you can separate a companys reserves by
geography and by Proven vs. Probable vs. Possible (which refer to the probability of
finding and producing energy), and assign different risk-weightings to each of them so
that you discount cash flows by different percentages in each segment.
Ive even seen models where people analyze each individual well separately, but that is
so time-consuming that its not too common.
For a simple example of the output from a NAV analysis, see this page.
Also check out this excellent interview with a reader who moved from oil & gas investment
banking to an energy hedge fund to see how he set up his NAV models in case studies.
You can also use a DCF analysis even for upstream companies, but the NAV tends to be
prevalent; public comps and precedent transactions are still used, but with the different
multiples I mentioned.
One difference in the DCF here is that you may separate CapEx into Drilling &
Completion (D&C) CapEx vs. Leasehold and Infrastructure CapEx, with the former being
sort of like growth CapEx (the cost of drilling new wells) and the latter more like
maintenance CapEx for normal companies.
And then you have actual spending in categories like acquisitions, exploration, and
development, which can be considered another form of CapEx.
You have to be careful with the assumptions youre making, because you dont want to
inadvertently imply that a company will grow cash flows at 5% indefinitely without
spending anything on drilling new wells.
Midstream (MLPs)
For MLPs, the most common valuation methodologies are price to distributable cash
flow multiples and the dividend discount model just like with REITs, MLPs must
issue a certain percentage of their earnings in the form of dividends, so the DDM works
quite well for valuation purposes.
Yields, though not technically a valuation multiple, are also very important since many
investors view MLPs as income-oriented investments (and they really are income
investments if you look at the dividend yield numbers).
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Distributable Cash Flow is basically cash available to Limited unit holders (as opposed
to the General Partners, or GPs) after paying for CapEx, other cash expenses, and
distributions to the GPs.
Technically, its defined as Net Income + D&A Maintenance CapEx Cash Flows to
General Partners.
You can create all sorts of metrics and multiples once youve calculated Distributable
Cash Flow, such as Distribution Yield (Distributed Cash / Price) and DCF Yield
(Distributable Cash Flow / Price).
Credit statistics (covered in your corporate banking article) are also important for
example, investors look at both coverage ratios (Debt / EBITDA) and leverage ratios
(EBITDA / Interest Expense) to assess which MLPs might be riskier than others.
Downstream (Refining & Marketing)
There are not too many differences in this sector because the companies are very
similar to normal companies in other industries.
So you still see EV / EBITDA, P / E, and traditional DCF analyses.
Q: Wow. Im amazed at how long youve been talking about this now.
Anything else to add?
A: Oh, Im not done yet.
You still see methodologies like the relative contribution analysis (compare how much
the buyer and seller are contributing in terms of net income, cash flows, reserves,
production, etc. and base the ownership percentages and implied purchase price in a
deal on that) and historical equity price comparisons (e.g. average closing price for
both participants over certain time frames).
Sum of the Parts can be common with the super majors and any company that has a
big presence in multiple sectors you might use the NAV model for the E&P segment,
DCF for refining/marketing, and a DDM for midstream (for example).
Q: Now youre done, right?
A: Haha, OK, two more and then Ill be done:
Ratio of Premium Paid to Capitalized Synergies in Precedent Transactions: This
analysis can employ either average daily closing prices or the closing prices themselves
on particular dates.
Return on Gross Invested Capital Comparison: Used for a single time frame (ex: ten
year) and looks at the entire company or particular segment (ex: Exploration &
Production or Refining & Marketing).
The standard definition for this calculation is "(Earnings - Dividends) / Total Capital."
Here, Total Capital is the sum of the debt and equity in a company.
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Energy Banks: Super Majors and Integrated Firms?

Q: OK, enough with the technical tips, my head is spinning great overview,
though.
What are the top banks in your space?
A: The top bulge bracket banks in the space are a familiar set, and most of the big firms
all have strong oil & gas teams as well.
The top boutiques are more spread out. Here are a few examples:
KLR Group focuses on the broad natural resources sector.
Rivington Capital Advisors, Simmons & Co., Energy Spectrum Advisors, Mitchell Energy
Advisors, and RBC Richardson Barr, RBC Rundle, Tudor Pickering Holt, and Raymond
James Albrecht also cover the sector.
Geographically, as youd expect, there are a ton of boutique energy banks in Texas, but
you also see them in hubs like New York and London as well.
Q: I noticed not all of your boutiques are really boutiques, whats the deal?
A: Depending on what year it is, youll see banks consolidate or move entire teams to a
less rocky platform so thats why Im including banks and groups like RBC Rundle
on this list as well.
Off Into the Sunset... Or Back for More
Q: What do you like to read to keep on top of the sector?
A: Oil and Gas Financial Journal features a section on M&A, as does Oil and Gas
Investor. DealBook is good too.
Notice Im not giving you the whole thing to read, just one section. :-)
For more acquisition and divestiture (A&D) reading, you can check out A&D Watch.
Q: So where do you go after youve done your time digging for black gold?
A: There are a lot of commodity [hedge] funds out there that really appreciate the skill
set you gain in covering oil & gas.
As previous interviewees have mentioned, there aren't a ton of PE firms focused on
energy because of the volatility in the sector, but they do exist and youd be wellpositioned for them after working here.
I've also seen people move to oil & gas companies big and small, and sometimes even
move into different industry groups in banking.
You definitely develop a more and more specialized skill set in oil & gas as you continue
in the field, so its easier to move into something different early on if you find its not for
you.
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The good news is that its easier to move from oil & gas into something else than to do
the reverse.
Q: Great. Thanks for your time!
A: My pleasure.
Luis Miguel Ochoa has worked in investment banking for several years covering the
industrial sector. In addition to being an avid mentor for his alma mater, he volunteers for
the Association of Latino Professionals in Finance and Accounting. In his spare time, he
is fencing, and attends networking events in New York. He has graduated from Stanford
with a BA in Economics.
M&I - Luis | July 15, 2013 at 9:08 pm | Categories: Investment Banking Industry Groups | URL:
http://wp.me/p9dt5-1YG
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7/16/13

canberk dayan <canberkdayan@gmail.com>

Tue, Jul 16, 2013 at 1:10 AM

New post on Mergers & Inquisitions