Malone Mitchell: Energy and Opportunity Overseas
Source: The Energy Report (3/19/09)
With more than 25 years in the business, Malone Mitchell, chairman of TransAtlantic Petroleum Corp., has not only endured but also prospered through seven downturns, turning assets he bought in the 1998 down cycle into billions. In this exclusive interview with The Energy Report, he discusses the business service modifications that enabled TransAtlantic to corner some select foreign markets, likens operating in Morocco and Turkey to operating in Texas, defines what he calls a 'friendly hostile bid' and explains why he's been waiting 23 years for this situation.
The Energy Report: Can we start with your macro overview?
Malone Mitchell: Sure. I started in the business 25 years ago and have seen seven downturns and six upturns, and that’s one of the great things about the industry—it provides a constantly changing opportunity to do business. If you tried to execute the same business strategy for 25 years, you’d be disappointed. So long as you’re willing to change every three to five years, it’s a great business. The business obviously made a very radical change starting last summer. Where once anybody could get any amount of money to develop any prospect and virtually any play anywhere that would pay off economically, now the market is pretty selective.
We had anticipated—certainly not the day—but we had anticipated that things were getting a little frothy just because we’ve seen these cycles before. I had pulled about a billion dollars out of some former energy investments and actually chose to go international with our company.
From a macro standpoint, the thing I’ve come to find out over and over, when everybody says it’s going to be great, it’s about to go the other way; and when everybody says it’s going to be horrible forever, it’s about to turn and get better. I am pessimistic with regard to the price of natural gas in the United States. I think it’s a shale play. . .it’s like the laws of physics have changed and, if you weren’t cognizant of the change in the law of physics, you’re going to be hurt by it. I am optimistic with regard to natural gas prospects we see internationally, in Europe or the European consumer basins, where they’re dependent upon Russia for their supply. I think that there continues to be a pretty strong-arm control of prices that will take quite some time to moderate. Unlike natural gas, which you find anywhere you drill and is normally found at deeper depths, I think there is a much more finite supply of oil, so I believe that we’re probably going to see a recovery in the price of oil.
Generally, I think we may see a recovery in the price of oil as early as the second half of 2010. Having studied economics, not oil and gas, in college, I tend to believe that we’ll solve these economic crises the same way every prior require society has, by debasing our currency, by inflating our way out of it. I think we’re going to see higher oil prices and fairly high gas prices.
TER: You say you see it going higher. Do you see it going lower here? Do you see a possibility of it going to $25?
MM: We’ve hedged virtually all of our product. I do see the possibility of it going lower. Investment is falling at such a rapid rate. I read pretty avidly every day, but it’s hard for me to get a handle on exactly where all of our economies are going to bottom out at and how low consumption will drop.
I’ve got a lot better sense of the supply side of the equation than I have the demand side of the equation and that’s probably the new variable. So I can tell you that supply is going to be impacted dramatically in everything but United States natural gas. I just cannot tell you how rapidly it’ll go down. That being said, I have hedged virtually all of our production for the years 2009 and 2010, and I have hedged all of our natural gas production domestically in the United States through 2012.
TER: Where do you see opportunities? It sounds like you’re looking internationally.
MM: I started with $500, literally, and no more than $22,000 in total paid-in capital, and built one of the 10 largest production-operated privately held producers in the U.S. (and the largest privately held drilling company in the U.S.). We were the second largest under-balanced company in the world behind Weatherford. We’re very active as a service business.
Over that period of time, we tended to grow by acquiring companies and then by focusing on reducing the operating costs associated with those companies by virtue of owning our own mid-stream and service divisions. So we’ve been through a number of cycles in the U.S., where we bought service companies and we sold our under-balanced companies to Weatherford International Ltd. (NYSE:WFT). The largest acquisition Chevron made in 1994 was Pakenham field in West Texas and then, of course, we were fully active there.
We started looking about a year and a half to two years ago more seriously at the international market. For the last 20 years, we’ve seen prospects come to us that, typically, had a number of things in common. There had been a few wells drilled by a large oil company 20 years ago that had what would be considered by U.S. standards very good oil and gas shows, but that had not led to full-scale development by the large company. At that time, we didn’t have the capital, the people or attention to devote to following those prospects.
In the mid-1990s, we did work in South Africa and in Canada, but were probably still a little thinly capitalized to be able to develop those opportunities. About a year and a half ago, we started reviewing prospects internationally because we thought competition, for land both within and outside of the shale plays of the U.S., had become very fractionalized and it’s very difficult to put together a meaningful acreage position on something that we thought was going to allow us to have substantial reserves. So, in the process of doing that, we started studying a number of foreign countries and foreign prospects and wound up taking a majority stockholder position in Transatlantic Petroleum Corp. (TSX:TNP). In doing so, we found an existing management group, which had largely come out of Arco and had managed its Mediterranean area.
When BP (NYSE:BP) acquired Arco, BP decided to divest virtually all of its onshore properties other than the Bolivian asset, so they left behind a team of land people, geologists and engineers who were knowledgeable on all these field areas where Atlantic Richfield had been exploring for years. What we found in that company was the beginnings of a decent acreage base, but very insignificant capital to be able to develop anything. They were really just looking to farm out properties.
In the process of working with them, we’d been looking at expanded opportunities with other companies. We recently made what I would call a ‘friendly hostile bid’ for Incremental Petroleum Ltd. (ASX:IPM), which is listed on the Australian Exchange. I believe we’ll be successful at acquiring over 90%, and then cash merge the balance within the next two months into TransAtlantic; we work in joint ventures with a number of other companies. One of the companies I’ve been very impressed with is Sterling Resources Ltd. (TSX:SLG).
They have the largest gas discovery in probably the last 10 years, in the North Sea, that they’re developing. They have large gas resources in the Romanian Black Sea they’re developing. They struck me as being very competent people. We reached an arrangement with them to jointly develop a 1.6 million acre block that they had in Romania. I think I’m one of their five largest shareholders now.
We are also in the process of negotiating with a number of other companies. We could name a number of companies, but I think because we’re in negotiation, it might verge on insider trading.
TER: We don’t want to do that. What are other areas?
MM: We’re focusing on areas that allow licensing, which means you can own your reserves rather than production sharing agreements, that have stable to moderate governments. We do not look in the ex-USSR areas. I have also done a lot of business, for a lot of years, in China and have partners in India. I just do not feel that those countries represent an opportunity for us on reserves.
Currently we’re active in Morocco, Romania and Turkey, and we’re actively looking at assets in Tunisia, Italy, the Netherlands and Bulgaria, and in addition to companies and properties in those areas. The thing that we felt would make a difference in all these countries is to bring our own service equipment. We had mobilized our own drilling rigs and a substantial amount of other equipment to these countries and we think that that will enable us to reduce costs considerably.
We just acquired the second largest oil field in Turkey. It’s been developed on a density basis of about 5% of what any comparable field and comparable reservoir would in the U.S., so we’ll have the opportunity to see if our deeds can match our words.
TER: Malone, of all of these countries that you’re looking at, are you looking at oil or natural gas or a combination?
MM: In Turkey and all of these countries, you’re receiving $12 an MMBTU for natural gas. I look at gas prospects that are proximate to good markets and good pipeline systems that have two- to three-month payout in Turkey and Romania. I look at oil properties that, when you look at just the amount of oil that’s been recovered out of the last wells drilled in the field, you just can’t find that in the U.S. anymore.
We continually see fairly low-tech completions and stimulations that produce results that just can’t be done in the U.S. Most of these countries don’t have any stimulation equipment within the entire country. In fact, today we decided to go ahead and add the acidizing as a service that we would provide in the country of Morocco in our service company for both ourselves in other companies, and there is literally no one doing that in the entire country. If you want to acidize a well, you call Europe and you get something shipped out of Europe with a mobilization charge that’s in the hundreds of thousands of Euros.
TER: Are there other public companies that are developing in Morocco?
MM: Yeah, there are two companies that are operating—a company named Circle Petroleum. Circle has recently drilled some very successful gas wells in Morocco. All of these, I think, are mostly AIM-listed companies. Another company that’s active over here that we have relations with, and that seem to have a very good program, is Cabre.
Our company in Romania will probably be the most active operator in the country next to the State Oil Company. In Morocco, we will be more active than the State Oil Company. The difference is you come over here to any one of these countries—Romania or Turkey—both of these countries offer relatively the same amount of promising geology as the state of Texas. In Texas, there are areas that you don’t drill; the geology’s not suitable. Both of these countries have roughly the same amount of promising geology.
During the last upswing in Texas, there were over 800 drilling rigs running. In either Turkey or Romania, you may have no more than 10 rigs capable of drilling at any one time. The level of development here is comparable to the Permian Basin in Texas in 1938. The shallow giants have been found but they’ve not been thoroughly developed. The separate fault blocks that would be great fields in the U.S., but modest fields internationally, have not been defined by seismic and most of the deeper plays have never been drilled.
In Romania, it’s very common to see wells that are only 3,000 or 4,000 feet deep; but when you shoot 3D across it, you see phenomenal structures that are 6,000–9,000 feet deep. In Turkey, there are only 40 or 50 oil wells in the entire country that have penetrated below the cretaceous formation.
I might mention some other companies from a service company standpoint, really the only companies that you see over here are Schlumberger (NYSE:SLB), Weatherford, Baker Hughes Inc. (NYSE:BHI) and Halliburton (NYSE:HAL); so we think there’s an absolute opportunity for smaller service companies to make inroads into these countries and have very, very good profit margins relative to what we see in the U.S. because the competition is just so slim.
TER: Malone, can you speak to some of the geopolitical risks associated with being in the Eastern Europe?
MM: Now on a geopolitical standpoint, one of the things I believe to be true is that countries import the vast amount of their product. They don’t tend to nationalize the oil companies. The few producing countries where they export a major amount of their production, you’re probably in a position where the government is going to be renegotiating its take. From a geopolitical standpoint, Romania is obviously in the EU and the other countries that I mentioned in the EU operate on about the same basis as working with a BLM (Bureau of Land Management) in the U.S., but it is regulatory-intensive and what some people would consider bureaucratic relative to operating in Texas, but it’s certainly no more cumbersome than it is to operate on BLM lands in the U.S. and requires a similar amount of forethought.
As for countries outside the EU where we operate—Morocco and Turkey—I like to tell people that, to me, Turkey feels a lot like operating in Texas. Every time I go there, we’re completely surprised by the people, their work ethics and "can do" attitudes. Obviously, both countries have got factions in them that would love to upset the status quo.
From our perspective, having been the largest privately held drilling contractor in the U.S., the thing I love about these countries is I don’t have to worry about my roughnecks coming to work drunk or worry about drug testing. You really have as clean-cut a group of workers as you can imagine and, in general, I find that the troubles you have generally occur in a part of the country that you really shouldn’t be in anyway. So we’ve not encountered anything. We also operate, not on an energy basis, in South America, and there I ride around in bulletproof cars.
TER: Would there be a possibility for European countries to decide they’re going to nationalize strategic commodities, such as oil or natural gas, and wouldn’t that put your investments at risk?
MM: I think the same could be said nearly every day in the U.S. for the last couple of months. The fact of the matter is in Turkey—when we were having tight oil and gas during the last uptick when prices got to $150 in the U.S., and every day we had congressmen calling for windfall profit taxes—in Turkey we had a call for a reduction of royalty from 12.5% to 2.5% to encourage oil companies to make investments there.
In Morocco, we have a very minimal royalty and we have a 10-year tax holiday, so the fact of the matter is the fiscal regimes in every country wherein we operate are generally less than we have in the U.S. Yes, we do have a risk associated with a nationalization of working interest assets. Of course, the federal government already owns the minerals, unlike the U.S. or Canada, where it’s a blend of both private and public ownership. Here the mineral estate is owned publicly by the government.
If you look at these countries, the levels that they import and the levels that they produce themselves are so small. In Turkey, Morocco or even in Romania—Romania’s a little more—you’re dealing with the countries that satisfy less than 5% of their need for either oil or gas, so I think it’s likely they will continue encouraging foreign investment to try and build that for as long as they can.
TER: Are you familiar with a company called the FX Energy Inc. (Nasdaq:FXEN) in Poland?
MM: Sure. We had looked at FX and done some studies. One of the things I became cognizant of is that the cost of reserves, the cost of production for foreign companies, was much less expensive as just an investing shareholder rather than domestic companies. We did research on FX, invested in that, as well as BPZ Energy Inc. (AMEX:BPZ), another company that just stuck out in our research.
BPZ operates primarily out of Peru. Both FX and BPZ stuck out as the anomalies on our research about foreign companies that seemed to have outsized reserves relative to their market caps. We have targeted companies that we thought we brought more to the table from an operational standpoint.
TER: Domestically, where do you see the price of oil trading as we go through ’09 –’10? Can you give me a price point range?
MM: Yeah. Based on contango (a condition in which distant delivery prices for futures exceed spot prices, often due to the costs of storing and insuring the underlying commodity), we’re locked in as a company. We’re locked in with kind of floors at $40 and if you look at it on a contango basis, our ford strip on our crude oil leaves us taking very little capital investment risk that isn’t covered by an average $50 price we’re receiving for crude oil. I am all for it dropping. If it dropped to $20 tomorrow, it would delight me because I have capital and I don’t really have any debt, so it would put me in an even stronger ownership position. As far as a viewpoint of where that price is going, I guess if I had to—based on everything I know—I would have to say we’re going to be range bound here between $30 and $40; and, beginning in probably the middle of 2010, we’re going to see very rapid inflation in the country that is going to lead us to a much higher price with no greater purchasing power. But to the degree that we’ve invested in assets that reflect inflation, which crude oil reserves do, I think that’s a good thing.
MM: As an investor looking at oil and gas companies now, I go back to a pretty simple rule. When you only start with $500 and you only ever have $22,000 paid in capital, what is really important is how long it takes you to pay out the well, what’s your cash flow, what’s your real true free cash flow? I think that’s a point anybody looking at oil and gas companies or oil and gas projects today should be looking at. I think we built up over the course of time, from the ‘80s until mid-2008, where people were buying oil and gas properties and companies based on reserve ads and based on finding costs that were distorted by full cost accounting methods, and I think now all of that’s blown away and we’re really back to more of Warren Buffet “what’s the free cash flow?”— the basis of this industry. I have never, in the cycles I’ve been through, seen rigs laid down at the pace they’re being laid down.
TER: I know, it’s unbelievable.
MM: I’ve got large banks coming to me every week, basically saying these are the public companies we’re dealing in and these are the companies you’re dealing in. They’re going to have no credit and we’re going to take this cash flow. Who do you want to do a deal with? And, unfortunately, my view of credit is somewhat limited in the fact that I think you’ll only know you have credit when you get it, so we’re kind of looking at the cash we have a little more judiciously than we would have a year ago.
TER: As you’re looking at your cash more judiciously than you have a year ago, I assume that’s why you’re looking at these international properties. You’re feeling that, for every dollar spent, there’s more potential cash flow?
MM: It is. I think that we have the greatest assets. The assets that made me a billionaire were the assets that I bought in 1998 in that down cycle. For me, this time we’re in now is one of the best times to buy assets. I am taking the view that we’re TransAtlantic and with our private energy companies, we are going to sacrifice a little bit of early growth rate to remain unleveraged because, to me, just the certainty of knowing that you can make your debt payments because you don’t have any is a good thing. We are going to put in place the business plan, which always served us well in the U.S., which is we’re going to own large acreage blocks, we’re going to own the service companies outright, we will own as much of the mid-stream as we can, we’re seeking to own approximately half of the working interest in the blocks we have and we’ll seek to bring in other oil companies or private investors who have more or less been my partners over the last 20 years and/or new partners. We will provide the services on a basis that’s not higher than could be got from some third party, but on a basis that would be considered retail, while we earn our 50% pay on a wholesale basis. That particular business plan has generated a lower payout period and a more stable business plan for us over the past 25 years. Most oil companies don’t like to do the service part. That’s when you get involved with a whole lot of people and you get involved with all of their issues. At the end of the day, somebody’s got to do the work.
TER: Early on, you said that you’ve been through seven downturns and six upturns in this industry.
MM: I’ve been through seven down cycles and six up cycles and numerous changes where everybody thought this is the way you have to run your business or you’re not cutting edge.
TER: You also say that if you’re not willing to change your business every three to five years, you shouldn’t be in this business. Have you found that the same strategies that have worked in every downturn, the same ones worked in the upturns—or did you have to radically change even an upturn strategy?
MM: In an upturn, it’s my opinion that you should be doing what I did, which is sell and I don’t think anybody can name the day that the highest point is going to be or the day that the lowest point is going to be. A cursory look will tell you that we’re not in a never-ending downward spiral of demand and product price, but things will go back the other direction. We may not be all the way at the bottom, but they’ll go back. I think the biggest issue to overcome in a downturn like this is the issue associated with opportunity—opportunity is going to come to those people who can either have liquidity or get credit. And most of the prior down cycles that have occurred during my adult life, while there may have been depression in the oil industry, it wasn’t throughout the credit markets. . .throughout all industries. So if you had reasonable credit and a down payment, you could secure financing for your project.
This time, securing credit for projects—even if you have a AAA credit rating—a down payment is much more difficult. So this time I think the real opportunity will be for people who actually have cash on the balance sheet. And that was considered bad management practice up until this downturn began. Now, we shifted during the up cycle to a point where we had borrowed quite a bit because we felt like we were riding an up cycle, but in the fall of 2005 at the pricing on the highest day ever on natural gas, we decided to basically raise public money to deleverage our companies completely in December of 2005 because we felt it had become frothy at that point in time. It turns out we were high for the day by luck, a little early on the overall cycle, but I think on a macro basis, maybe that call.
Right now I think if you have cash and you can get up every morning and look yourself in the mirror and convince yourself not to be afraid, that the world will go on and we’re in a business that people will burn all the oil and burn all the natural gas you can come up with (people still have to house themselves, clothe themselves, feed themselves), and if every segment of that is dependent upon oil and gas, then these are going to be the great deals. I think we’ll make the best purchases in the next year than we will make in the remainder of my life.
TER: That’s pretty exciting.
MM: I’ve been waiting 23 years for this situation to come along again. The last time we were in this, in the early ‘80s, I didn’t have two nickels to rub together. Now I have somewhat more than two nickels.
From 1985-2006, Mr. Mitchell built Riata Energy into one of the largest privately held energy companies in the United States. In 2006, Mr. Mitchell sold controlling stake in Riata Energy. Later, Riata Energy was renamed Sandridge Energy (NYSE:SD). Near the time of sale, SandRidge Energy had 1 Tcf in proved reserves, 300 miles of gas gathering pipeline, greater than 34,000 horsepower of gas compression, and owned or operated 43 drilling rigs.
Shortly after stepping down from SandRidge, Mr. Mitchell founded The Mitchell Group ("TMG"), a privately owned oil & gas exploration and production company. TMG includes Riata Management and Longfellow Energy.
Prior to his involvement with Riata Energy and The Mitchell Group, Mr. Mitchell worked in the oil field services industry and was employed with his family's ranching and aviation businesses.
Mr. Mitchell graduated from Oklahoma State University in 1983 with a Bachelor of Science degree. He is actively involved in venture capital and agriculture businesses.
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