Kate Richard grew up in the ultimate company town, Oklahoma City, where virtually every adult seemed to labor for King Oil, and dinner-table talk revolved around the newest exploits of the industry’s flamboyant wildcatters-turned-tycoons. As a youngster, Richard thrilled to her grandfather’s stories of sinking the earliest wells in Angola for what’s now Conoco, and the accounts from her great uncle—a founder of Devon Energy—of planting platforms in the Caspian Sea off Azerbaijan following the fall of the Soviet Union. The anchors of everyday life regularly made way for drilling: Richard heard tales of how a high school sports facility was moved to accommodate a rig and pumpjack, and that airport runways got rerouted to turn the tarmac into an oilfield.
Richard graduated from Harvard in 2004, practiced investment banking for Goldman Sachs, and then vetted energy investments for Michael Dell’s MSD Capital. But when Oklahoma City became the capital of the shale oil revolution, the 28-year-old returned home and launched an oil and gas private equity fund—Warwick Energy—in 2010. At the time, oil prices were hovering around $90 per barrel. She was intrigued that even with crude at those historically lofty levels, the big drillers were somehow generating mediocre returns; nor was she confident prices would remotely remain so high. Richard recalled that crude was selling for $17 (the equivalent of $32 today) in the mid-1990s when she was a teenager, and although Oklahoma City was far from a boomtown, producers had made enough money to keep pumping plenty of the thick black stuff.
So in those heady times, Richard took an unusually cautious, analytical approach to investing. She used sophisticated analytics to target small patches of land where drillers could produce profitably in times of cheap oil. After prices collapsed in late 2014, her Warwick Energy Group profited in a period when most private equity shops showed poor results, and a number of independent producers either went bust or struggled through restructurings that pounded their share prices.
Today, Warwick Energy manages three funds with around $1.5 billion in assets for pension funds, college endowments, and family offices. Her firm’s performance numbers are proprietary, although Warwick’s data-driven strategy is designed to produce strong returns at relatively low prices, such as those prevailing today.
For Richard, those prime areas are the future, since they contain plenty of reserves to keep the shale industry roaring. Indeed, the big producers are prospering once again by concentrating more and more of their rigs and budgets on the kind of super-low-cost areas that she targeted from the start. And the recent drop in prices to $47 in early May makes the quest all the more urgent. “Despite what’s widely believed, low prices haven’t led to the collapse of the U.S. oil and gas industry,” Richard observes. “The fact is that OPEC can’t stomach $40 to $50 oil; at those prices they can’t fund their national budgets. But the U.S. shale producers are showing that they not only survive, but thrive at $40 to $50 oil.”
While examining shale investments at Goldman and MSD, Richard was mystified by the gap between the returns producers were promising and what they actually delivered. “They kept saying they’d generate 40% gains in their presentations, but in reality their corporate ROEs were 10% or less, at $90 oil,” she recalls. Richard suspected that companies were simply raising more and more money based on those rosy projections, and acquiring more and more acreage, at inflated prices, to keep showing growth to Wall Street. “I thought we could develop a strategy that was far more profitable,” she says.
As an outsider, Richard didn’t have access to the data that might explain the wide discrepancy. “To see the numbers, you had to be in the business at the well ownership level,” she says. “That was the major motivation in starting a private equity fund.” When she got to examine the proprietary data on costs as an investor, she saw loads of fat, including exorbitant payments for leases and drilling services. “It confirmed my suspicions that entire fields simply wouldn’t work even at what were historically high prices.”
Richard built her portfolio piecemeal by purchasing ownership interests in thousands of individual wells, and tens of thousands of acres yet to be developed. She bought those interests from owners as diverse as majors such as Exxon, and local farmers and ranchers. Then drilling and fracking is performed by contractors such as Baker Hughes, Halliburton, and Schlumberger. In a typical deal, Warwick might buy the rights to anywhere from 1% to 50% of the oil and gas produced from the well, in exchange for funding a corresponding proportion of the capex.
Richard avoided such high-cost areas as the Bakken in the northern Plains States. Instead, she focused on two then-little-known regions in central Oklahoma, nicknamed the Scoop and the Stack. Around 2012, companies such as Newfield began the first horizontal drilling and hydraulic fracturing in the two areas.
For Richard, the prime, core portions of the Scoop and the Stack were an ideal fit. They boasted what she calls “good rock.” That’s a blend of key advantages. First, the wells produce a combination of oil and natural gas; it’s pressure from the gas that sends oil gushing from the rock through the pipe. “In many shale wells, it’s primarily water that forces the oil out, and it can be extremely expensive to dispose of,” says Richard. “With wells where oil is primarily propelled to the surface by natural gas, you have lower costs because you don’t have to deal with the water, plus you get extra revenue from the gas production.” The Scoop and Stack are also crisscrossed by pipelines, lowering transportation costs.
“In the Scoop and the Stack, we can break even $30 oil, and 20%-60% returns at between $40 and $50,” says Richard. Indeed, it’s the fast growth of such low-cost areas that’s counterbalancing the declines in expensive parts of areas such as the Bakken and Texas’s Eagle Ford, and igniting a resurgence in shale production. For example, the rig count for horizontal drilling in the Scoop and Stack has risen by 49% since July of 2014, when prices hovered around $90. It’s a similar story in the best portions of the Permian in Texas and New Mexico. In the Permian’s Midland and Delaware Basins—areas providing returns approaching those of the Scoop and Stack where Warwick is also an active buyer—17% more rigs are at work today than at the peak of 2014.
In April, U.S. shale production rose by an impressive 109,000 barrels per day over March. That bump lifted output to almost 5 million barrels, just 10% below the all-time high of 5.5 million. And if the trend continues, shale production could reach 6 million barrels by early 2018. Of course, that’s far from certain, especially given the recent slide in prices.
Still, Richard spotlights three trends that should keep U.S. shale thriving. First, the industry has become far more efficient. Producers have substantially lowered corporate overhead and obtained deep discounts on both new leases and rates paid to contractors who do everything from supply pipe to sinking the wells.
Second, low prices have produced a gusher of creativity. “Shale is really a play on oil patch ingenuity,” Richard says. “The downturn has been a boot camp for the industry.” Shale producers are relentlessly experimenting with new ways to extract more and more oil at lower cost. “They’re improving the use of sand and ceramics,” she says. “They’re designing different wells to fit different geologies more than ever before. And they’re finding ways to extend the length of the horizontal wells up to two miles to get more oil from the same well.”
The third factor is the most important: The focus on the “core-of-the-core” low-cost areas that Richard has targeted from the genesis of Warwick. “Think of an oil and gas basin as the real estate market in Manhattan,” she says. “At $100 a barrel, all parts of the basin—or in our example, all of Manhattan real estate in a great market—make good returns. In the lower-for-longer oil price environment we’re in today, you need to be in the oil patch equivalent of 5th Avenue real estate, meaning in the best part of the basin.” That’s oil’s prime address, where top quality of the rock provides for strong returns even at low prices.
Combined, those factors mean that the U.S. will remain the world’s swing producer. “Although it takes six months from the decision to drill to first production, U.S. supply is viewed as ‘just in time’ inventory,’” says Richard. U.S. producers can respond to a spike in prices by hiking supply relatively fast. By contrast, in many OPEC nations, projects can take three to seven years before the oil starts flowing.
But for Richard, it’s pure entrepreneurial resourcefulness that sets the U.S. industry apart. It’s the multitude of independents vying for the best properties, even the folks in the bars and gas stations swapping stories about the new drilling techniques that work or flop. It’s the teeming, hothouse environment that sold her on the romance of drilling as a kid, and her hometown now reminds her of another crucible of innovation. “Oklahoma City is the Silicon Valley of the U.S. oil and gas industry,” she states. Kate Richard is bringing wonkish analytics back home to the prairie, all in a journey to mine the oil that flows from the “good rock” and that’s always been in her blood.
