Themes from Q4 Earnings Calls

Part 2: Mineral Aggregators

Mineral and Royalty Rights Special Topics Valuation Issues

In our Themes from Q3 Mineral Aggregator Earnings Calls digest, we noted common themes of increased acquisition activity, relatively flat aggregate production despite increased production from private E&P operators, and a sense of continued optimism.

In Part 1: Themes from Q4 E&P Operator Earnings Calls last week, we noted themes of cost inflation, a shift in production focus from natural gas to liquids, and macro policy headwinds. This week, we focus on the key takeaways from the mineral aggregator Q4 2021 earnings calls.

Discipline in Elevated Pricing Environment

Mineral aggregators are showing signs of discipline in the execution of large-scale acquisitions. The Q4 earnings calls highlighted, for the most part, management’s willingness to continue the trend of acquisitions, but noted the difficulty in doing so. As mineral aggregators focus on delivering high cash flows to investors, an incremental focus is being placed on ground game acquisitions.

  • “Just because we’re being even more selective than we historically have on the acquisition front, that doesn’t mean we’re in the market to divest any of these assets. What we want to do is take the assets and just generate the absolute maximum amount of cash flow that we can out of them.” – Tom Carter, Chairman and CEO, Black Stone Minerals
  • “I think anything over $50 million becomes more challenging for private equity portfolio companies to pull the trigger on. There are certainly very deep-pocketed private mineral buyers, but I think once you start getting to the higher dollar amounts, there’s just fewer and fewer people that are capable of biting off those chunks. There are some deals in the marketplace right now that we’re looking at. I just think the bar is high to get something done. We don’t need to do any deals. We’re in a great spot right now. I mean, I think we want to continue to grow. We want to get the company bigger. We want to realize economies of scale and increase float and liquidity and do accretive M&A. But we’re not going to go and do something that’s stupid. So I’d say that, it’s challenging to successfully pull things off.” – Davis Ravnaas, President & CFO, Kimbell Royalty Partners
  • “Yes. It’s tough to get deals done right now. I mean animal spirits have come back into the mineral market. There’s still a lot of small private mineral clippers and mineral buyers that have little funds that are competing with us. I think the beauty of Viper is that we can do a $500 million deal like Swallowtail, but also source and execute a deal like the other deal we did in Q4. But we’re seeing some pretty frothy numbers being paid for DUCs and permits…So, we’re going to be prudent, we’re going to be patient, and we’ll see how this frothy market continues.” – – Kaes Van’t Hof, President, Viper Energy Partners LP

Stagnant Production

Mineral aggregators noted continued capital discipline while prioritizing cash flows to shareholders, with operators primarily tapping into existing DUC inventory in order to capitalize on current prices. Furthermore, drilling activity slightly decreased in Q4.

  • “Tailwinds continue in the global energy sector and fundamentals across the U.S. energy complex continue to improve. Inventory levels are low. Rig count growth is tepid and operators continue to focus on balance sheet strength and free cash flow generation. Having said that, we do see drilling activity from private operators outpacing that of public company operators as they move more quickly to capitalize on higher commodity pricing and build scale.” – Robert Ravnaas, CEO & Chairman, Kimbell Royalty Partners
  • “However, here in the U.S., the DUC inventory levels are alarming. Since the peak of DUC inventories in the summer of 2020, DUCs across all basins have decreased 50% from 8,900 to 4,500, and Permian DUCs have decreased 60% from 3,600 to less than 1,400. If you continue to forecast the average drawdown in Permian DUCs of 125 per month since December of 2020 and project that same pace into the future, we have less than 1 year of Permian DUC inventory on the books. The shales are bare. That and the other factors compounded together tell us very clearly that prices are headed higher.”
    – Bud Brigham, Founder & Executive Chairman, Brigham Minerals, Inc.

Strength in Position Amid Inflationary Environment

In last week’s Part 1: Themes from Q4 E&P Operator Earnings Calls, upstream producers indicated expectations of inflation in the upper single digits. Mineral aggregators exhibited a more relaxed tone regarding anticipated inflation. As commodity pricing surged in recent periods, mineral aggregators reaped the benefits and expressed optimism on the impact to their bottom line. The high pricing environment has more than offset any cost inflation seen within operational expenses. Executives have lasered in on their business models — expressing rightful optimism that comes with having royalty rights amid the current pricing environment.

  • “At the end of the day, though, with $95 oil, $100 oil, the GTM [gathering, transportation, and marketing expenses] is just really not affecting our bottom line all that much. As I was commenting before, at this point, our EBITDA margins headed towards 85%. So it’s — most of our expenses just aren’t going to move the needle. But I think certainly, you could — we’ve set it up to capture any potential cost inflation that would be there.”
    – Blake Williams, Chief Financial Officer, Brigham Minerals, Inc.
  • “As of the end of the fourth quarter, private operators comprised 43% and public operators 57% of our active rig count, we were positively impacted by surging commodity prices, especially natural gas which contributed to our record quarter and the operational momentum we experienced in the second half of 2021 has Kimbell in an excellent position entering 2022. The oil and natural gas royalty sector is particularly well positioned to benefit from the inflationary cycle that has recently accelerated in the U.S. since royalty companies participate in the upside from commodity price inflation and do not experience a significant service cost inflation currently impacting the upstream sectors.” – Robert Ravnaas, CEO & Chairman, Kimbell Royalty Partners
  • “Looking ahead to 2022, Viper is uniquely positioned within the industry to be able to capture numerous tailwinds and return substantial amounts of cash back to our unitholders. With zero capital requirements and only limited operating costs, royalty companies will be advantaged in 2022 as we will not face inflationary cost pressures. For Viper specifically as our defensive hedges placed in 2020 roll off at the end of 2021 our industry-leading cash margins will now be further enhanced by mostly uncapped exposure to strength in commodity prices.” – Travis Stice, CEO, Viper Energy Partners LP

Mercer Capital has its finger on the pulse of the minerals market. As the Oil & Gas industry evolves through these pivotal times, we take a holistic perspective to bring you thoughtful analysis and commentary regarding the full hydrocarbon stream, including the mineral aggregators with working and royalty interests in the underlying production. For more targeted energy sector analysis to meet your valuation needs, please contact the Mercer Capital Oil & Gas Team for further assistance.