I am extremely pleased to report that on October 22nd, Five States closed the largest oil and gas property acquisition in its 36-year history. It was big enough in fact, to warrant splitting the acquisition between two funds and allowed us to complete full deployment of the FSPA 2020 fund capital less than 16 months after the fund was closed. Given that the fund started when the pandemic brought our industry to an abrupt halt, this speaks to just how quickly our industry has come roaring back.
The six acquisitions for FSPA 2020 occurred during the complicated market environment we face right now; one that looks much different than any in our recollection. To say that our industry is complex is an understatement, but to imply it has gotten even more complicated requires some explanation.
Five States Business Pressures
With the benefit of hindsight into the Five States business model in the late 20th century, our business environment looked straightforward and the pressures we felt were relatively few.
To summarize, Five States unlocked value for our investors by finding excellent assets and bought them at a fair market value adjusted for risk. Our biggest challenges usually arose from competitors chasing the same assets and OPEC actions that served to surprise everyone and destabilize the market. Commodity price volatility was usually our friend, working in our favor because we could exploit price cycles to buy or sell assets at opportune times to improve fund performance.
Changed Business Setting
In the 21 years since the turn of the century, we find that there are more business pressures now and asset acquisitions look much different. Now, in addition to price volatility and asset quality, there are a host of other factors with which we must contend.
Some of these work in our favor, others work against us, but the two most significant (and urgent) right now are the last two… a shortage of investment capital and a shortage of labor coupled with supply chain disruption.
Investment Capital Shortage
Speak to any independent operator with a development program and you will hear a consistent theme, that investment capital for development is missing. The causes of this are rooted in several areas including tightening lending standards at banks, institutional investor need to return cash to investors, social concerns about climate change, and government focus on renewable energy. All of this is keeping investment capital on the sidelines. As you may have read in the last issue of The Producer, this is working in Five States’ favor because sellers are starving for investment capital and willing to sell high quality assets at a discount to raise money. This is how most of our recent acquisitions were brought to us. The good news for Five States investors is that there is no sign of this going away soon.
Of note is that the social concerns and political initiatives arising from climate change are serving us well and are bringing attention to our newest fund – Five States Renewable Energy Fund that opened to new investors this fall (see page 7).
Labor Shortage and Supply Chain Disruption
Labor shortages and supply chain disruptions are affecting nearly every aspect of the world economy right now and unfortunately, are affecting our industry too. They put upward pressure on operating costs which burden the income of individual assets and of course, negatively affect fund performance. So we are watching for changes in operating costs very carefully and weaving expected increases into asset valuations when we bid on properties.
But there is a positive aspect for Five States funds because our assets are largely proved, producing fields with stable operators, many of whom have long-term employees on salary. So a large fraction of our asset operating costs are not as susceptible to near-term market forces as they would be if we relied heavily on contract labor, contracted drilling, and contracted service work.
Conclusion
Five States continues to keep our finger on the pulse of the energy environment (both conventional and renewable) on behalf of our investors. That environment has become much more complicated in the last two decades, but this complexity has revealed excellent opportunities that feed well into our business model and the work we do on behalf of investors.
We appreciate all of you who continue to place your trust and confidence in Five States. We look forward to navigating through this complexity with you in the coming months and years.