Thursday, October 29, 2015
8:00 a.m. Pacific | 10:00 a.m. Central | 11:00 a.m. Eastern
DrillCo Transactions
Michael P.
Darden, Partner
Robin S. Fredrickson, Partner
Michael R. King, Partner
Jeffrey S.
Munoz, Partner
. Agenda
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What is a DrillCo, and what Inspired It?
Recently Announced DrillCo Transactions
DrillCo Structure
Typical Terms
Benefits of Transaction to Operator/Investor
Inhibitors to DrillCo Transactions
Typical Transaction Documents
Governance
Budgeting
Security for Investor’s Obligations
Potential Off-Ramps
Earning/Reversion of Interests
Transfers of Interests
Provision of Services
Marketing/Hedging
Other Issues
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. What is a DrillCo?
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Not a “Co”
Not a cookie cutter transaction- structure tailored to needs
of parties
Resembles drill to earn structure- generally no up-front
cash consideration paid by Investor
Basic structure involves contribution of development
acreage by Operator and cash by Investor
Can cover either a large or focused area
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. What Inspired DrillCo?
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. Recently Announced DrillCo Transactions
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Linn-GSO:
• execution of transaction announced July 2015
• GSO to make $500MM available over 5 years
• No defined geographic area
• GSO to receive 85% WI, and will carry Linn’s 15% WI
• Upon Investor achieving 15% IRR, 80% WI (8/8ths) of
GSO to revert to Linn
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. Recently Announced DrillCo Transactions (cont.)
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Legacy-TPG:
• execution of transaction announced July 2015
• TPG committed to fund $150MM available for up to 3
years
• Permian Basin focused
• TPG to initially receive 85% WI and will carry 60% of
Legacy’s WI
• Multiple reversion scenarios based on TPG’s ROI and
IRR
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. DrillCo Structure
OPTION #1 | Operator Acquires New Assets
OPTION #2 | DrillCo Funds Existing Assets
Operator’s Existing
Undeveloped Assets
Newly Acquired Assets
Producing Wells
Development Wells
100%
25% Initial Carry
with Reversion
Operator
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25% WI Initial
with Reversion
100% of Capital /
75% Initial WI
Operator
Investor
Operator pays for 100% of Acquired Assets, which include Producing
Wells and future Development Wells
Producing Wells:
─ Operator receives all PDPs
Development Wells:
─ Investor Funds 100% of D&C costs on Development Wells in
exchange for an 75% working interest in these wells (Operator receives
a carried 25% working interest)
─ After Investor achieves a 14% IRR on a well-by-well basis,
Operator’s working interest in Development Wells increases to 75%
(Investor’s working interest falls to 25%)
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100% of Capital /
75% Initial WI
Investor
Operator uses DrillCo to fund development of assets within its existing
portfolio
─ Investor Funds 100% of D&C costs on Development Wells in exchange
for an 75% working interest in these wells (Operator receives a carried 25%
working interest)
─ After Investor achieves a 14% IRR on a well-by-well basis, Operator’s
working interest in Development Wells increases to 75% (Investor’s
working interest falls to 25%)
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. Typical Terms of a DrillCo Transaction
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Contribution of development acreage by Operator (retains
any associated PDPs)
Investor acquires working interest in wells drilled
Investor pays for its working interest share of development
costs and some or all of Operator’s working interest share
of development costs
All or a portion of the Investor’s working interest reverts to
Operator upon Investor realizing an agreed IRR on
investment
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. Benefits of DrillCo to Operator
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Excellent structure for Operator with assets with
development potential and limited access to capital
Serves as an off-balance sheet development tool for
Operator
Benefits are even greater for MLPs:
• Allows MLPs to participate competitively in acquisitions
of less mature assets
• Allows MLPs to develop inventory as feedstock for dropdown transactions
• Avoids direct exposure to steeper decline curve
• Assets can be dropped into MLP when “ripe”
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. Benefits of DrillCo to Investor
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Generally, DrillCo structure is tailored for private equity
investors
Lots of capital chasing opportunities- DrillCo can provide
for significant capital deployment
Opportunity to leverage expertise of public company
management and resources not readily available to private
equity investors
Structures usually involve ROI/IRR thresholds which are
familiar to private equity investors
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. Inhibitors to DrillCo Transactions
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Commodity Prices
Inability of Operator to fund- no “skin in the game”
Lack of suitable assets
Fundamental disagreement about level of control afforded
Investors
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. Typical Transaction Documents
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Joint Development Agreement
Form of JOA
Initial Work Program and Budget
Form of Assignment (which contains reversionary
language)
Form of Memorandum of JDA/JOA
Management Services Agreement
Tax Partnership Agreement
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. Governance
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Addressed in JDA
May utilize an Operating Committee, similar to those used
in international JOAs or large-scale shale joint ventures
Most important function is approval of work program and
budgets
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. Budgeting
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Investor will typically have a cap on total investment
Investor commitment may be required to be used (if at all)
within a certain timeframe
Typically contemplate approval of annual work program
and budgets
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. Budgeting (cont.)
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Initial work program and budget generally approved upon
execution of JDA
Annual work program and budget typically provides for
small deemed approved overages
Possible to have multi-year work program approved upon
execution
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. Budgeting (cont.)
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Investor usually required to do most of its diligence on
assets prior to approval of annual work program and
budget
Investor may want approvals over certain items within an
approved work program and budget
• E.g.- on AFE basis, over wells not meeting certain
criteria, etc.
• Operators are obviously reluctant to grant such rights
Will need to address third party proposals, as well as
unobtained consents, maintenance of uniform interest
provisions and exercised preferential rights
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. Security for Investor’s Obligations
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Some Operators may not require, or Investors may not be
willing to provide, security
Parent Guaranty
Letter of Credit
Escrow Arrangement (Certain amounts paid into escrow in
advance)
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. Potential Off-Ramps
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Potential Off-Ramps:
• Investor may negotiate for right to pull out on periodic
basis
• Potential suspension of activities/funding commitment
for certain commodity prices
• Initial production targets not being achieved
• De facto off-ramp for subsequent development- failure
to agree annual work program and budget
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. MCLE Code
Record this code now:
2107051
All Participants will need to record this code on the MCLE
Activity Form to receive MCLE credit for viewing this
program. Download the MCLE forms (if you haven’t
already done so) from the “Additional Resources” section.
. Earning of Interests
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Interests are assigned to Investor upon earning events,
which generally relate to completion of well and payment of
associated costs
Earned interests are wellbore only and depth- limited
May be assigned on a well-by-well basis, or on a periodic
basis
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. Reversion of Interests
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Generally, some percentage of working interest assigned to
Investor reverts upon achievement of certain hurdles based
on ROI and/or IRR
Costs to be included in calculation of hurdles must be
carefully defined
Hurdles are calculated on “tranches” or “series” of wellsusually relate to wells within an annual work program and
budget
Reversion is automatic upon occurrence of hurdle, though
Operator will require documentation recognizing event to
be filed of record
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. Transfers of Interests
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Investor may restrict Operator transfers in wells until wells
are drilled or hurdles achieved
Operator will generally restrict transfers in wells until all
development costs are paid
Investor may also want tag rights, and Operator may want
drag rights, which implicate valuation issues
Operator may also desire ROFRs or ROFNs, especially
Operators that are MLPs
. Provision of Services
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Investor may require Operator to provide certain services in
connection with DrillCo activities
• Might include accounting, regulatory, engineering, land
services
• May require specific reporting requirements
• Might also request special assistance in a sale process
• Operator will be entitled to cost reimbursement and may
be entitled to an additional fee- do such amounts count
against IRR?
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. Marketing & Hedging
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Operator will usually want to market Investor’s entitlement
Investor may want to reserve right to take in kind
Each Party hedges for its entitlement to production
Are hedge outcomes included in hurdle calculations?
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. Other Common Issues
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AMI- should Investor have right to participate in other
operations in the vicinity of DrillCo operations?
Drainage- if no AMI, should Operator’s right to conduct
certain operations in the vicinity of DrillCo operations be
limited?
Title- should Investor have any remedies for title issues
discovered post approval of an annual work program and
budget?
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. Questions
Michael P. Darden
Houston, Partner
T +1.713.546.7424
E michael.darden@lw.com
Robin S. Fredrickson
Houston, Partner
T +1.713.546.7467
E robin.fredrickson@lw.com
Michael R. King
Houston, Partner
T +1.713.546.7439
E michael.king@lw.com
Jeffrey S.
Muñoz
Houston, Partner
T +1.713.546.7423
E jeff.munoz@lw.com
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