Energy Winners & Losers: Eagle Ford Plays

NEW YORK ( TheStreet) -- Marathon Oil ( MRO) is spending $3.5 billion to acquire a net 141,000 acres in the Eagle Ford, Texas, shale from Hilcorp Energy and Kohlberg Kravis Roberts, a deal that will double Marathon's Eagle Ford exposure and one it said will equal 80,000 barrels of oil equivalent production by 2016.

The implied price paid per acre for the 141,000 net acres in the Eagle Ford can be looked at two ways: the simple value per acre, which works out to $25,000, and sets a new high water mark for U.S. shale deals (by a wide margin of premium paid, too.) Taking into account the 7,000 barrels of oil equivalent (boe) production already coming from the acreage, the value of the deal would be as high as $21,000 per acre. Analyst estimates of the proven reserves and potential proven reserves would place the deal between $15,000 per acre and as high as $21,000 per acre.

Either way, this deal is at the high-end of valuations in the Eagle Ford and leaves investors with one question: Will Marathon Oil's paying up for assets in the Eagle Ford pay off?

Marathon Oil shares declined by close to 2.8% on Wednesday, though that was only slightly worse than the energy sector decline of 2.2%. Earlier in the day, before a market selloff reached its worst proportions since August, the decline in Marathon Oil shares was three times the decline in the energy sector. At the same time, the Marathon deal boosted some other independent exploration and production companies associated with the Eagle Ford in early Wednesday trading, but as the market losses mounted, the gains were mostly erased , though some of the Eagle Ford names had a much smaller decline than the broader energy sector or held onto small gains.

Swift Energy ( SFY) ended down 1% on Wednesday. SM Energy ( SM) ended the day up 1.9% (half of its morning gain), and SM Energy also announced the divestiture of $44 million in non-core Texas assets on Wednesday morning. In its release about the asset sales, though, SM Energy did allude to negotiations that are ongoing about its Eagle Ford acreage.

Pioneer Natural Resources ( PXD) was down 0.6% on Wednesday. Forest Oil ( FST) ended trading up 0.7%. The Marathon deal is in Pioneer's "wheelhouse" and Forest Oil has acreage in overlapping Eagle Ford counties.

Lucas Energy ( LEI), a more speculative name in the Texas shale plays, was up 13% to a share price of $3.20 on Wednesday.

EOG Resources ( EOG), one of the primary names associated with the Eagle Ford, was down close to 1% on Wednesday.

One energy analyst who does not cover Marathon and cannot be quoted on the deal said EOG and other major Eagle Ford players didn't rally extensively because the price paid by Marathon is so aggressive that the market won't assume other players like EOG Resources will receive similar valuations.

"Investors will struggle with a valuation above $20,000 per acre and if everything could sell at that price than all the stocks would be a screaming buy. Investors typically discount recent transactions metrics, and this one looks like a pretty full value for those assets, " the analyst said, adding, "When you are paying full value, it takes longer for the company to demonstrate that the price paid is adding value."

Furthermore, many of the major players in the Eagle Ford have already joint ventured assets, and for their stocks to rally on the Marathon deal there would have to be the assumption they will be selling assets outright in the foreseeable future, which isn't the case across the board.

Even some of the stocks that were receiving a minor boost from the Marathon deal don't have plans to sell their Eagle Ford assets soon, and therefore they don't receive an implied value of as much as $20,000 per acre if there isn't the likelihood of the assets being shopped any time soon, analysts noted.

Analysts, even those who believe that the deal will pay off for Marathon long term, viewed the pricing as aggressive.

"It's a rich multiple any way you slice it," said Raymond James analyst Pavel Molchanov.

Kevin Cabla, analyst at Raymond James, said the pricing is bullish, even at the low-end of estimates and taking into account proven reserves.

Phil Weiss, analyst at Argus Research, said the initial reaction is a mix of the high price being paid and the actual acreage resource being more valuable than previous deals indicated.

"It's some of both. Sustained high oil prices do provide some valuation support," the analyst wrote in an email to TheStreet.

Three recent Eagle Ford deals valued acreage between $10,000 and $12,000.
  • In June 2010, Reliance Industries paid an implied value for Eagle Ford acreage owned by Pioneer of $12,000 per acre.
  • In October 2010, China's Cnooc (CEO) paid an implied value of $10,000 per acre in a Eagle Ford deal with Chesapeake Energy (CHK).
  • Anadarko Petroleum (APC) received a valuation of $16,000 per acre for Eagle Ford assets sold to Korea National Oil, which had been the highest per acre priced paid previous to the Marathon deal.
  • Scott Hanold, analyst at RBC Capital Markets, said by and large deals are not revalued across any shale play based on one deal's valuation metric.

    "Investors don't revalue acreage on a single transaction, and this has been true of joint ventures and transactions on acreage in the past," Hanold said.

    RBC's Hanold is not among those on the fence about the aggressive pricing in the Marathon deal, though. RBC estimates that the adjusted price including the value of proven reserves at 7,000 barrels of oil equivalent production is $21,000 per acre.

    "This is some of the best acreage in the Eagle Ford and Marathon saw the potential and was willing to pay up for it," Hanold said. He estimates that Marathon will be able to generate an investment rate of return of 15% to 20%.

    "The value of the acreage, in my opinion, is there," the RBC analyst said.

    Raymond James' Cabla sees the logic in Marathon's big paycheck, too. The Eagle Ford is not only one of the largest shale plays in the U.S., but deserves a premium for being lower risk than other shale plays, such as the Niobrara.

    "Longer term, Marathon realizes this is steady production and lower risk production which will provide positive cash flow for a while. Versus exploring offshore or international, you know what you are getting when you go into Texas," Cabla said.

    Raymond James analysts concurred with this view, writing in an email to TheStreet that Marathon has had a lackluster exploration track record in the past. "With that in mind, investing in low-risk, reliable production assets like the Eagle Ford makes sense for them. While somewhat of an apples to oranges comparison, this transaction may be preferable to racking up multiple dry holes pursuing international exploration."

    Raymond James and other analysts believe the price paid per acre dims excitement now, but that will change over time. "The price still looks too rich to get too excited about the transaction right now. Of course, whether it pays off depends on where oil prices go over the next few years. For reference, our long-term oil price deck is $125 for WTI," Raymond James wrote.

    The issue is that investors look at the headline price paid Wednesday in contrast to a four-year time horizon for Marathon to prove that the Eagle Ford acreage will up production from 7,000 boe to 80,000 boe.

    "There is no doubt it's expensive and I'm not surprised Marathon is getting a little beat up for it, but longer term it's not a bad move. Investors won't give them credit for that now, though longer term I think it will pay off," Raymond James' Cabla said.

    -- Written by Eric Rosenbaum in New York.


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