Oil producer Earthstone to acquire fellow Permian small-cap Independence

Houston — Small-cap upstream producer Earthstone Energy said Dec. 17 it has agreed to buy West Texas Permian Basin operator Independence Resources Management for total cash and stock of nearly $186 million, bulking up the acquirer's holdings in the US' most prolific oil basin and paving the way for it to forge further transactions there.

Privately held Independence comes with production of 8,780 b/d of oil equivalent (66% oil) in third-quarter 2020, raising Earthstone's existing production of 17,000 boe/d more than 50%. The company was formed in 2014 with funds from private equity firm Warburg Pincus.

The acquisition also showcases 16.3 million boe of proved undeveloped reserves across 4,900 core net acres, 93% operated, in Midland and Ector counties, Texas, and an additional 38,000 net acres, 100% operated, in the eastern Midland Basin.

The Midland Basin is the eastern part of the greater Permian in West Texas.

Earthstone CEO Robert Anderson said the transaction is an "important" step in the company's growth strategy to "further increase our scale with high-quality accretive acquisitions."

"This is consistent with our stated strategy to be a consolidator in the Permian Basin and positions us well for additional value-enhancing transactions," Anderson said.

"We will maintain strict financial discipline as we consider future transactions," regarding both valuation and balance sheet strength, he added.

Key asset: Spanish Pearl

The deal, which gives Earthstone Independence's Spanish Pearl field, a key asset straddling Midland and Ector counties, is expected to close in first-quarter 2021. The field is surrounded on all sides by producing wells.

Independence's 48 horizontal, or unconventional, wells produce from four prolific zones – Middle Spraberry, Lower Spraberry, Wolfcamp A and Wolfcamp B. Its acreage has 70 future well targets with average 45% internal return rates at strip pricing, as well as additional upside locations, Earthstone said.

The acquisition has been unanimously approved by Earthstone's board and by the members of IRM, Earthstone said, adding "no further approvals are required."

The transaction comes amid a recent sizeable string of corporate merger and acquisition, or M&A, announcements – many involving large E&P operators. For example, in the last couple of months, ConocoPhillips moved to acquire Concho Energy, Devon Energy said it would acquire WPX Energy and Pioneer Natural Resources agreed to take out Parsley Energy. In Canada, Cenovus said it would buy Husky Energy.

All are multi-billion dollar deals, and were announced just days or a few weeks after Chevron closed its acquisition of Noble Energy.

Small-cap M&A is occurring as well, although with fewer fireworks. Last month Southwestern Energy closed a $193 million acquisition of Montage Resources, which gave the gas producer a bigger footprint in the Marcellus gas basin of Appalachia. And in late October, Contango Oil & Gas said it would buy Mid-Con Energy Partners for an all-stock deal of Oklahoma assets valued around $400 million.

The driver was the uncertain direction of persistent low oil prices felled by demand destruction stemming from the coronavirus pandemic.

Oil prices up, but outlook still damp

Now that vaccinations against the virus have begun and are expected to continue through 2021, oil prices have risen about 20% from months of hovering around $40/b for WTI and $43/b-$44/b for Brent in second-half 2020.

But wariness over safety for travel and large-venue gatherings for sports or cultural events may linger, leaving a cloudy outlook on the timing of demand pickup.

Earthstone said its purchase of Independence will be accretive on all key financial metrics. Post-acquisition, the company's pro forma net debt to EBITDAX will remain at 1.1x – a low level historically but by current standards is either typical, near-typical or a goal for many producers, particularly those held publicly.

Under the deal terms, consideration to be paid to Independence consists of roughly $135 million in cash, which is expected to be lower on the closing date, and roughly 12.7 million shares of Earthstone's Class A common shares valued at $50.8 million based on a $3.99/share closing price on Dec. 16.

The cash component of the transaction is about 70%.

Earthstone is currently running a single rig on its properties and is likely to continue that pace even after the combination.