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Life of a small-cap driller in the Permian, 20 acres at a time

The Permian Basin is the premier location for U.S. oil and gas deals, both big and small. While most attention has focused on the multi-billion-dollar deals for thousands of acres of land, some small companies including Lilis Energy are buying up land 20 acres at a time and getting a second lease on life in the process.

San Antonio-based Lilis Energy struggled its way through 2015, finding itself on the verge on bankruptcy. Active in Colorado's DJ Basin at the time, Lilis took an impairment charge on its assets in the third quarter of that year, and low prices presented a dire outlook.

"All of our spuds in the DJ Basin were no longer profitable," CEO Abraham "Avi" Mirman explained. "We had to write everything down. By the fourth quarter, it was either go bankrupt or reinvent ourselves."

With help from financial backers, Lilis combined with Brushy Resources, a small cap company located in the Permian. "They were $33 million in total debt. They were victims of redeterminations, couldn't drill a new well. … They were just a sitting duck," Mirman said. "They could file for bankruptcy and sell their assets to pay off some of their lenders, or hook up with another distressed company."

The two closed a $13 million merger in June 2016. "We went to the same investors two months later and they were willing to give us another $50 million. It was a big win for us, and that put us in the driver's seat. We were one of the only well-funded microcaps in the basin."

Regina Mayor, KPMG national sector leader for energy, natural resources and chemicals, said the "Permania" currently exhibited by the U.S. oil and gas industry would make it difficult for a company of Lilis' size to repeat their feat.

"I think it's going to be tough for smaller companies to get in and expand now," she said. "Now that you've got major players like [Royal Dutch Shell plc] and [Exxon Mobil Corp.] going in in a big way, companies of that size take a lot of opportunities away."

The combined company started with 3,450 acres in the eastern portion of the Delaware Basin, and, by March, had built up a position covering 6,424 acres in Winkler and Loving Counties, Texas, sometimes as little as 20 acres at a time. Mirman said the leases have averaged less than $5,000 per acre. Companies like Shell, Matador Resources Co. and EOG Resources Inc., are some of the operators nearby, but Mirman said Lilis has still been able to find acreage to add.

"Every bit helps us," he said. "Our goal is to get to 10,000 acres by mid-year, and I think we'll get there. We want to get to 15,000 to 20,000 by the end of the year and I think we'll do it organically. Compared to other operators, that's a huge percentage gain in terms of leasehold."

Mayor said organic growth in some parts of the play may also be getting tougher as sellers begin to look at opportunities elsewhere.

"Most of the sales that were being made were by private equity, and they're starting to look at other places," she explained. "If you're a smaller company now, opportunities to buy may come in the SCOOP/STACK in Oklahoma, the Eagle Ford [Shale] or the Powder River Basin."

Lilis' 2017 drilling program called for 10 wells targeting the Wolfcamp formation, with 5,000 foot to 7,500 foot laterals. The company expected to spend between $6 million and $8 million per well, with estimated ultimate recoveries ranging from 738 to 915 Mboe per well. Its Bison #1H well achieved a 30-day initial production average of 2,144 Boe/d, of which 74% was liquids. Its Grizzly #1H well had a 30-day initial production average of 1,323 Boe/d, with 63% liquids.

While Mirman said Lilis is looking for opportunities to drill and expand, KPMG's Mayor noted that smaller companies in the Permian are now looking for drilling success in order to sell out.

"One thing we haven't seen as much of as we expected in the Permian has been IPOs," she said. "A lot of these small companies that are private are drilling, putting out laterals of a few thousand feet, fracking it, looking for solid returns and then trying to sell. They've decided that it's better to get 85 cents on the dollar and start again than going through the hassle of trying to go public."