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Talos Dives In

The story of Talos Energy LLC is one of a seasoned team backed by two private equity providers to build a company in the Gulf of Mexico. Little did they know that the group would also be a part of history as the winner of two blocks offshore Mexico in the country’s historical first lease sale in more than 70 years. Now they are ready to dive into a new adventure in creating value.

The team, led by president and CEO Tim Duncan, formed Talos in 2012 with equity commitments of up to $600 million from Apollo Global Management and Riverstone Holdings, to execute an acquire, develop and explore strategy based on 3-D seismic data in the Gulf of Mexico and lower Gulf Coast.

The Houston company holds blocks in the Gulf of Mexico from High Island to Main Pass, in both shallow and deepwater areas. Net production was 28,000 barrels of oil equivalent (boe/d) in the third quarter of 2015, with more on the way. Last fall Talos logged 600 feet of pay in eight new reservoirs in its Phoenix Field on Green Canyon Block 237; the company is currently finishing work to bring on production from the thickest pay sand in the discovery well and plans to spud another well to be drilled to 21,000 feet, deeper than the traditional pay sands in the field.

CEO Duncan hopes to take Talos public some day, and he thinks the company needs a unique edge in order to do so. Certainly, drilling in Mexican waters fits that bill. Because Talos is an expert in interpreting seismic data—it has one of the largest datasets in the shallow waters of the U.S. Gulf of Mexico—and because it could obtain data from the Mexican side, Duncan thought Talos had a good shot at success in the first bidding round.

After Duncan spoke at Hart Energy’s Offshore Executive Conference in November, we caught up with him to get more details.


Investor How does your experience in the U.S. Gulf qualify you to get involved offshore Mexico?

Duncan At first blush, you might not think that a company of our size would be competing in a country opening in Mexico. But our legacy is in shallow water—that’s how we’ve built two companies in the past—so getting involved in shallow water in Mexico made a lot of sense for us. I and two of the other Talos founders, John Parker and Steve Heitzman, have been working together for 15 years as a team. Initially we worked together at Gryphon Exploration, and then later at Phoenix Exploration. [Note: Gryphon was sold to Woodside and Phoenix was sold to a group led by Apache.]

Our business model was to use private equity capital to deploy the very latest seismic technology, particularly in shallow water, with an emphasis on reprocessing seismic data. Our strategy has been to apply cutting-edge seismic technology to mature hydrocarbon-producing areas in order to identify opportunities that may not have been identified by previous operators who were using older seismic technology.

As an example, at our last company, Phoenix Exploration, we took an old salt dome that had produced about a trillion cubic feet and was producing about a couple million cubic feet a day; we took an old 1994 seismic data set and a 1999 data set, merged them together, and reprocessed it; we were then able to successfully drill several wells in the salt dome and we were able to increase production in the dome to 18 million a day.

And two miles south of the dome, about 1,500 feet below the original field pay sands, around 20,000 feet subsea, we found an additional 300 to 500 billion cubic feet equivalent [Bcfe] of potential resources that are now producing over 100 million cubic feet per day [MMcf/d]. That’s a good example of what we’ve been trying to accomplish in each of our companies.

Investor Is your model any different this time with Talos?

Duncan We’ve had nice luck selling companies in the past, but in putting together Talos, our view is M&A is not an exit we can rely on. Our belief is that we have to increase the scale of the company enough in order to possibly take it public, and if we want going public to be a viable option, we need to differentiate ourselves.  

Investor Is that why you turned your sights on Mexico?

Duncan As Mexico began opening up their market, we started asking ourselves, "Does it make sense for us to go look at it?” The assets available in Mexico have the chance to be long-lived assets underpinning our shorter-life assets on the U.S. side of the Gulf.

And if we’re in the public market one day, we think it’s important to have long-term growth stories, and Mexico could be one of those.

In addition, given that our assets in the U.S. Gulf of Mexico generally have a low R/P ratio, the chance to lengthen that R/P ratio was very appealing as we look to potentially market the company in the future. If we have success in Mexico, that should lengthen our R/P ratio significantly given the size of the opportunities we see there. And we knew that if we were going to take a shot, we had to be there early when the market hopefully remained inefficient, and not wait for the second or third lease sale.

Investor That track record gave you confidence, right?

Duncan Definitely. We’ve put over a billion and a half dollars of capital to work at Talos in about a three-year period, with much of that funded through internally generated cash flow, and we were producing 28,000 barrels equivalent a day in the third quarter of 2015—yet two and a half years ago, we only had five employees. We’ve gone from no production to 28,000 barrels a day in a pretty short amount of time, which gives us confidence in our ability to build companies.

One thing I would point out is that about half of our reserves are in shallow water and half are in what we like to call "developed” deepwater. We’re not doing cutting-edge deep, deepwater exploration. Our model is more about drilling around proven tracts where there’s infrastructure in place, chasing deeper pools in and around wells that were drilled circa 15 years ago or older. We have over 400,000 net acres in shallow and deepwater, and over 33,000 square miles of seismic to make sure we are doing as much as possible on these assets with current technology.

Investor So tell us more about the Mexican opportunity.

Duncan I was reading an article in 2013, one of the early articles about the Mexican energy reform. What I did not want to do was look back on participating in the opening up of the Mexican Gulf of Mexico and say, "I didn’t even think about it.” So I talked to our sponsors about it. Admittedly, this was very early in 2014.

Initially, there wasn’t a whole lot of interest in thinking about this, because we really hadn’t put Talos together to explore internationally in new countries. But I’m talking to bankers, I’m talking to contractors; I’m just trying to figure this out. We think we have very talented geological and geophysical staff and a talented operating team. I just wanted to figure out how to get them down there, so they could assess their view of the opportunity. I thought, there has to be a ton of potential—we just needed data.

Investor So seismic data played a big role in your final decision to bid?

Duncan Yes it did. One of the interesting things about this process is that the government could have made it difficult to get data, but they didn’t. If they’d made the barriers of entry too high, if the data packet had been several million dollars, they would have narrowed their list of players to the majors, the sovereign funds and the NOCs. But they made their data affordable, allowing more forms of capital and more competition, and that allowed guys like us to go in and work the data and develop a potential resource to bid on.

Investor What did the data tell you?

Duncan What we realized when we got into the data is that Mexico has many similarities to our U.S. Gulf of Mexico shallow-water assets, with similar subsea depth, similar-aged rock and similar rock properties. Given that Pemex operated these assets without the competition that you see in the U.S. Gulf of Mexico, we believed that the available assets had not been reviewed and exploited to the degree one would see with assets in the U.S. Gulf.

So we picked up 160,000 acres in that first sale in Mexico. The basin has generally been a carbonate play and we certainly see carbonate potential; but in our U.S. Gulf of Mexico operations we’re dealing with salt traps, sub-salt plays, salt domes, and big three-way closures. That’s the geology we’re used to. So we focused on opportunities with the geology we are familiar with, and we were pleasantly surprised in all the Pliocene and Miocene opportunities we were able to acquire.

We have a number of defined prospects on each of the two blocks we acquired. We’ve built an attractive economic model that incorporates our return hurdles.

Investor Can you say what those hurdles are?

Duncan They are based on a model that allows us to capture shallow-water efficiencies, to provide the Mexican government its required take, and to still attain the return on capital our private equity owners expect.

Investor How did you figure out a bid in such a new opportunity?

Duncan We had to find the right bid structure that worked for both us and our partners when what you’re actually bidding is a percent of government take. We had to incorporate the operational cost estimates in order to make the bids economic. Based on those inputs, we are able to put in competitive bids.

Investor How did you eventually hook up with your partners?

Duncan We’ve got great partners on this acreage. Sierra Oil & Gas is a historic first-ever private equity-based Mexico City start-up, and it’s a sister portfolio company of ours with Riverstone as a sponsor.

We also have Premier Oil, a global explorer based out of the U.K., which gives us a partner with a global reputation and who we think validates the opportunity.

Once you construct your bid and submit it, all you can do is hope at that point. We knew that we had to show up at the first sale. I get the question all the time about how we evaluated the competition. We knew that certain larger players would show up while others could afford to wait for the process to play out a little bit. They can pass on a few bid rounds, and I expect the terms are going to get a little better with each lease sale.

For those larger players, they can take a nice, measured pace because they have a lower cost of capital. Frankly, they can compete against anybody. For us, on the other hand, we’ve got to pick our spots, fly a bit under the radar. We believe we’re very good at the G&G and operational aspects, but we know our cost of capital is a little higher.

We had to show up early when the process was a bit more inefficient and there’s just a little less competition. We made a decision that our move was going to have to be in that first sale, that we were going to take a chance and hope we identified the right stuff. There were 14 tracts available and over a million acres.

We were very lucky, because both the blocks we won were competitive, and we were able to just narrowly win them with our bidding structure. I think that’s when we realized we really had acquired some attractive properties.

Investor What comes first now that you’re there?

Duncan Our job now is to execute on the minimum work program. That’s our obligation under our contracts with the government, so it’s obviously something we take very seriously. As part of our efforts, we have to integrate local content, so that is something that we are also working on. We have been quickly building out a dedicated Mexico team, and we expect to open a small office in Mexico City soon.

We are also conducting a baseline environmental study and we are in the process of submitting our exploration plans. With respect to seismic data, we’re in the midst of reprocessing the seismic data Pemex gave us and that alone is a 12-month turnaround, typically.

Investor How has the government been to work with?

Duncan I think the government has been very transparent and they are doing a nice job of listening to industry. They want to build robust regulatory policies, but they also want industry input to make sure they aren’t so robust that they limit activity and competition.

Above all, they want to ensure that private industry develops the resources that Pemex has been unable to develop. They’ve clearly opened the doors to every form of investment. If you look at what happened in the second sale, you had the likes of Lukoil, Eni, and CNOOC all bidding, as well as companies similar to us. You really had almost every form of capital you can imagine, including sovereign wealth, majors, JVs and private equity. I would expect that’s exactly what the government wants out of the reform process.

Ultimately, what we need to do to get where we want to be is to underpin our story with something uniquely different, something that hopefully separates us from the other folks in our basin, and there are some very good companies in our basin.

At some point we had to take a chance. We saw the lower commodity environment—as painful as it is for us all—as an opportunity to go in and take a chance when maybe others would be standing back. 

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The original article can found at Oil & Gas Investor. http://www.oilandgasinvestor.com/talos-dives-832691