At the heart of the U.S. natural gas industry is the Appalachian Basin, covering a congested hive of competitors and their wells stretching from Ohio to Pennsylvania at a time when Henry Hub prices appear to be lurking in the $2-3/MMBtu range. A typical classification would see such operators being labelled as conventional or unconventional exploration and production (E&P) firms – but one West Virginia operator and his crew don’t quite fit that plain vanilla classification.
Meet Rusty Hutson, Founder and Chief Executive Officer of Diversified Gas and Oil (LON:DGOC), who goes after “low decline, long life natural gas and oil assets” that have fallen out of favor with their original drillers and operators.
“We take over assets, explore avenues for optimization, increase efficiencies, cut costs and improve yield of wells that are not top of their previous owners’ lists but would yield hydrocarbons for years. We are pretty consistent in how we operate and what our long-term goals are – resource maximization and enhanced recovery,” Hutson tells Forbes in an exclusive interview.
And at a time when others are looking to scale down activity, fearing sub-$2 Henry Hub prices having overextended their E&P activity, Hutson claims his company is one of the few options out in the Appalachian with room to buy assets looking for a new home.
Barring sporadic ownership of small scale oil wells, much of DGOC’s portfolio consists of natural gas plays with a 100 to 150 year-potential. “While we drill very few wells and mostly acquire and operate, some wells we have on our portfolio were drilled as early as 1895.”
That portfolio currently stands at over 60,000 wells with a headline production rate of 92,000 barrels of oil equivalent per day (boepd) or 525 mmcf per day. It remains on a “high growth trajectory”, making Hutson’s London-listed company the largest conventional producer in the Appalachian Basin with an intriguing backstory written in the midst of dominant unconventional E&P companies.
Hunting for value in West Virginia
Despite being a fourth generation oil and gas man, Hutson says he didn’t enter the industry until 2005 having spent much of the earlier career in banking.
“My family, from West Virginia (WV), has worked in the oil and gas industry for decades. My father is still working for me today at the age of 72. My grandfather worked in the industry for 56 years, and his dad for 40 years. Between all those years of service, I grew up around mostly around the blue collar aspect of it. Dad often came home covered in oil having had a day of old school drilling site hard labor.”
So when Hutson graduated from Fairmont State College (WV), employment in the oil and gas business was the “last thing” he wanted. Instead, two stints in banking between 1992 and 2005 followed, after which he finally took the plunge into the sector.
“In fact, the journey started in 2001 before I quit banking after my Dad brought a small package of wells in WV to my attention that I subsequently invested in, with the help of partners and a home equity loan.
“We drilled more wells and dabbled in natural gas. In 2006, we made a $5.5 million acquisition of a company called Diversified Resources. Seems small now, but was pretty big at the time, and that’s when we changed the name of our company to DGOC from multiple asset names. It gave us a platform to venture outside outside of WV for the first time and acquire assets in Eastern Ohio in the region of a couple of 100 wells.”
The company was only producing 2,000 boepd and then the shale boom happened. “Suddenly, unconventional was all the rage, while we were only after conventional type assets. When Henry Hub prices hit $2 in 2012, we started noticing that there were conventional wells sitting around our wells that no one seemed to be interested in. Many operators had moved on to shale neglecting these wells completely. We simply needed capital to take advantage of what we saw as divestiture opportunities by these companies.”
Hard path to a London listing
By the end of 2014 oil prices had dropped and banks had curbed lending to the sector. Private Equity players were around, but Hutson says he’s never been a fan of theirs. “A public listing seemed logical but we were way too small for U.S. markets at the time with an EBITA of $7-8 million.”
Armed with a compelling corporate narrative, Hutson turned his attention to London’s Alternative Investment Market (AIM), a popular calling for small cap resources firms in 2015. “We did work for an AIM initial public offering (IPO) but couldn’t find a broker who would take us on. So having done the leg work, we went for an unsecured microbond on the ISDX [Now “NEX”] raising $13 million.”
That money paved way for what was to follow, as DGOC did a couple of “transformational transactions” in Pennsylvania that gave Hutson’s crew the clout and size for an eventual IPO. Hutson finally got it off the ground in February 2017 via a $50 million IPO with a projected EBITA of $10 million 12 months out.
“That phase was the longest two years of my life, but it was worth it because we had a compelling resource maximization story to tell investors, which has since been realized and we march onwards and upwards. Our thinking reflects in our existing portfolio, and also in the kind of assets we are always on the lookout for. Be that as it may, if distress in the industry sends whole companies our way, we’ll look at them too.”
DGOC deploys smart hedging, and is not afraid of long-dated hedges of 10 years or more. The company takes the back end of the price curve that’s got some contango, and brings some of that value forward by deploying a mixture of physical and financial contracts to protect cash-flow and minimize price volatility.
“We are able to do things that the drilling and development companies can’t do. A lot of these companies have outspent their cash-flow, drilled massively and are returning no equity to shareholders. In our case everything we are doing is very low cost from existing wells, putting them back in production and moving natural gas from infrastructure that is already there, with no escalating drilling costs to worry about. So they cannot lock in $2.50 prices, we can even make $2 work!”
Investors are beginning to take notice of that either side of the Atlantic. Putting things in perspective, the company that Hutson IPO-ed back in Q1 2017 represents a mere 3% of DGOC as it exists today in terms of production and revenue. “That’s how much we have grown since February 2017 whilst remaining a cash generative, dividend paying and return on equity focused company.”
Even income funds are sniffing DGOC out and Hutson is not surprised. “For many of them, we resemble royalty trusts that are doing very well right now. They also get confidence from the fact that I have skin in the game being company’s largest individual shareholder (3.08%).”
In September, the DGOC formalized its intention to move from AIM to the London Stock Exchange’s main market. “We’ve acquired $1.4 billion worth of assets, and raised about $750 million of equity in London. Move to the main market is about enhancing our credibility and we don’t mind the additional scrutiny that’s likely to bring, including the rigors of convincing foreign institutional investors.”
Employees not contractors
Hutson says DGOC would be nowhere without its employees, and there is a saving and control psyche in there too. “In less than three years, we’ve grown from 35 employees to under a thousand spread over four U.S. states, out of our headquarters in Birmingham, Alabama. Barring few exceptions, they are almost always employees and not services contractors.”
That’s because the DGOC boss, and his “go to person” Brad Gray, Chief Operating Officer, believe employees feel more of a sense of duty and ownership of the asset than contractors who just bill and do an onsite job.
“Where we acquire an asset, we tend bring the operating company’s team responsible for the site into our fold as employees. Of course, headcount does get realigned up or down, but we’re nearly thousand strong and hiring. Over 80% of our current well portfolio will cost less than $25,000 to plug, and cost average is currently in the region of $23,800 per well; you don’t get those kinds of economics with an army of contractors.”
Some of these multi-million dollar buys of assets, and talent acquisitions have come about courtesy divestment drives by the likes of CNX and Anadarko Petroleum. In July 2018, DGOC bought 2.5 million in acreage from EQT Corp.’s Southern Appalachian division for $575 million, bringing with it more than 6,400 miles of gathering pipe and 59 compressor stations.
More of the same
As his company grows, if Hutson ought to be worried about a low price environment, he clearly doesn’t show it. “DGOC has the mentality and people to make any price environment work. I am not sitting here with you sweating about near-term natural gas prices and how they will impact my business. Were that to be the case, then I haven’t done my job properly.
“I should be thinking of prices 12 months out and beyond. We are already hedged for the next 12 months, and in parts well beyond that. We know now what our production is going to be 2 to 3 years out with allowances for minor declines and what our cost is, adjusted for inflation. In any case we don’t have high operating costs like E&P folks.
“In many plays, we’re OK at $1.20/MMBtu. Our cash-flow remains stable, and so at $2 prices we can hedge and make a 40% margin. Absolute numbers might be lower but you are still healthy coming out on the other side when prices do go up, and if its $3 we’re dancing! Ours is not only an obsession with efficiency, its just how we do things.”