Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

If you want to understand why OPEC is having such a hard time squeezing shale producers out of the energy market, look no further than Rice Energy's multi-dimensional, $2.7 billion acquisition of Vantage Energy.

Yes, it's a natural-gas deal, not oil. But that isn't the point. The point is that a deal of this scale, requiring this much new money, for a commodity this beaten down, is getting done at all in the U.S. exploration and production sector.

Gas has rallied recently, although $3 per million BTU counts as enough to get a high-five from bulls these days.

$3, That's The Magic Number
Natural gas prices have rallied, albeit from very low levels
Source: Bloomberg
Note: Generic 1st-month natural gas futures contract.

But the U.S. gas market is a patchwork of regions, with local pricing often markedly different from the benchmark Nymex futures price because of constraints on pipeline capacity. Such is the case in Appalachia, where Rice and Vantage have their core assets:

Going South
Natural gas prices at the Dominion South Point hub in Pennsylvania have slipped back below $1
Source: Bloomberg

So sentiment overall is better than it was but hardly jubilant. Certainly, you might think a gas producer would have some problems going to investors and telling them it wants to raise more money selling new shares than it did at its IPO less than three years ago.

But Rice seems to be handling it.

To fund the deal, Rice is pulling multiple levers. Its selling almost $1.2 billion of new shares (including the greenshoe), which is more than it raised when the stock debuted in late 2013, according to Bloomberg data. It's issuing roughly another $1 billion to Vantage's private equity owners. All in all, the 85.1 million new shares are equal to a staggering 43 percent of the existing number outstanding.

In addition, Rice will immediately sell the pipeline assets that come as part of the package to its master limited partnership, Rice Midstream Partners, to cover $600 million of the cost. That money will come from a combination of the MLP using debt and selling new units or just handing some over to Rice.

The seemingly endless appetite of U.S. capital markets is what has enabled the country's E&P firms to withstand OPEC's onslaught better than many expected heading into this crash.

Stocking Up
Despite (and because of) the crash, 2016 is a banner year for U.S. E&P stock offerings
Source: Bloomberg
Note: Data for 2016 are year-to-date through September 27th.

That isn't to say Rice is just riding a wave. It has managed rapid growth while keeping its borrowing in check -- a rare feat these days.

Part of this is down to savvy use of futures: Rice's average realized gas price last year was $2.21 per million BTU before hedges but $3.18 -- 44 percent higher -- after. Indeed, one of the attractions of Vantage, other than its main acreage sitting neatly next to Rice's own, is its own hedge book. Roughly two-thirds of pro forma production next year is hedged.

Rice's stock has been a star performer this year, despite the company selling another $561 million of stock in April to help fund another deal. The same goes for Rice Midstream, which has trounced the broader MLP sector.

The Rice Is Right
Rice's two securities have surged this year
Source: Bloomberg
Note: Performance indexed to 100.

So Rice is taking advantage of investors' generosity -- including Rice Midstream's current cost of equity below 4 percent -- and liquid futures markets to keep expanding. In the process, the deal also offers a way for Vantage's private equity owners to cash out and back into an established, listed stock rather than continue down the path of trying to IPO the company themselves.

Is it an option open to everyone? No. Earlier this summer, I noted the club of E&P companies coming to the stock market to raise more money had shrunk somewhat compared to 2015. Equally, though, any company able to claim real estate in the Permian basin seems able to name their price.

It's a trend that appears unsustainable if energy prices remain depressed and if interest rates should rise. But it's appeared unsustainable for quite some time already. And now along comes this Rice deal.

OPEC may be showing some fatigue in its battle to recover market share. Until it finally beats the capital markets into submission, though, it should soldier on.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net