Achieving a High IRR in Oil Without Market Risk

[BlackLine Resources + 12]

Goal for an energy investor? To achieve a high IRR, (Internal Rate of Return), in excess of 25% with a properly structured transaction based on existing oil and gas production... without the market risk of most oil and gas investments... How?

These returns can be enjoyed via use of strategies that are commonplace to the market, but in unique combinations.

The requirements?

1.  Buy the production at a discount

2.  Evaluate the producers capability to deliver what is purchased

3.  Hedge the acquired oil/gas to eliminate the market risk

Taking each one at a time..

By striking production purchases with a niche group, the smaller independent, oil/gas can be essentially 'rented' for a term under a stated delivery schedule obviating the risks of onerous working interest structures, joint venture follies, drilling and equipment issues, etc.   The bonus?  These style of transactions are NOT bank loans, non-recourse and NO equity give away to secure the funding.  The producer will 'sell' a percentage of his production, the amount determined by what their capital needs are and how much production they actually have.  More on this in a minute.

Evaluating the producer's capability to deliver is the linchpin to making these transactions work.  Can they produce the amounts under the delivery contract for the length of the term?  Engineering and a succinct development plan are crucial to ensuring the investor will be repatriated.  Any investor will require a third party engineering review/report to be effected.  Once the determination is made whereby the producer has the existing production AND a development plan with realistic CAPEX built into the capital advance and both sides are content with the metrics, the process continues.

Hedging the acquisition... the desire is to avoid ALL market risk... a put is purchased on every barrel in the transaction, matching the delivery schedule.  Suffice it to say, this is where each  transaction takes on it's unique profile and structure to get to the high IRR the investor seeks.  Seasoned, structured finance professionals need to be employed to maximize the returns via this strategy with corresponding counter parties who need to be the best out there to secure these returns, (think BP, Koch, Cargill).

As the producer receives the advance, they are free to deploy the capital as they see fit.  However, depending on the percentage of oil/gas the investor purchases, they are in a position to utilize their development plan to augment their remaining production which happens to be 100% accretive to their remaining percentage of production.  The investor is on a delivery schedule for a terms, they're not there for any upside, so the producer can hopefully turn his existing field of X barrels to X+ with the use of the investment capital.  At the end of the term, the producer gets all of his production returned, as the delivery contract has been satisfied.

The use of these structures are becoming more commonplace which in today's market, are becoming more popular with small to medium sized producers. 

For the producer, much needed capital and for the investor, a wonderful IRR that can't be overlooked...