The Exchanges

Q How did the idea of that forever hold dovetail with the initial expectations of this is probably going to be like any other deal you do with a five-year hold?

A It was around 2011. I think we really started talking about that more directly between ourselves and the management team. Before that, we hadn't really talked about exit much at all, but we had a successful investment going into 2011, and I just remember calling up the CEO of the business and just saying, most of the management teams really start thinking about exits around this point in time. You're four, five years in. At that point in time, we were Three to four X ROI on the investment. When you go into a deal with the management team, they're always worried that the private equity firm is going to sell the business out from under them at some point in time. The vast majority of the deals that we're in when we actually exit is because the management team wants to sell more so than us. And there's very logical reasons for that. Almost all of their net worth in a successful deal is involved there. They start to get really worried about concentration levels and the like. I think one big advantage that we had in this deal is that our management team was very successful before Crown Rock. They weren't looking for their next dollar to go on vacation or buy a new home. They were very well set up even before that. So they had the flexibility of taking a very long-term view. And when we opened the door to them that the private equity firm, Lime Rock, were not necessarily beholden to …

AI assessment note: “we opened the door to them that the private equity firm... were not necessarily beholden”

Q What were those other two extinction events that happened?

A The other two, just before Thanksgiving in 2014, Saudi Arabia, and by extension OPEC, essentially declared war on shale. They set out to reclaim market share after tremendous amount of shale growth had really cut into the market share of OPEC from the 2010 to 2014 period. And 2015, which followed this announcement, was a complete wipeout. I mean, oil prices fell by 50% again. The rig count went from 2000 rigs to get as low as 304 hundred rigs. More bankruptcies than you had ever seen in the oil and gas business since the 19 eighties. I think in hindsight, we can look and say a lot of those 2000 rigs were very unproductive and were not focused on the best resources in the country. And that moment where Saudi said, we can put you out of business whenever we want. Really focused the industry to be much more high-graded overall in the most productive resources in the U.S. So there's entire plays that were, 405 hundred rigs were running that are completely wiped out and have barely re-emerged in the years since. It also really strengthened the focus on the Permian Basin, which is where fortuitously all of our investment was located within Crown Rock, and that proved to be by far the most resilient of the basins. You could Drill there at that point in time at oil prices below 30 dollars a barrel because service costs adjusted at the same time, too. And it also prompted an acceleratio…

AI assessment note: “just before Thanksgiving in 2014, Saudi Arabia, and by extension OPEC, essentially declared war”

Q What did it take to do that labor intensive work for the management team to go find the properties on this supplemental side of the business?

A We had a huge advantage in that our management team all existed and lived in the Permian Basin. They were Midland, Texas guys. Most of the oil and gas business is outside of Midland, Texas. It's in Houston. A lot of it at that point in time was in Denver or Tulsa or Dallas, but our team was entirely in the Permian Basin. Most of them had lived their entire lives there. Bobby Floyd, who was our chief Head of land and president of the company, co-founder of the business, was a fourth generation Midland, Texas oil and gas guy. So they had very deep relationships with landowners in and around. They'd had multiple other endeavors in the Permian Basin previously, so they had a lot of credibility. When you go to a landowner and you tell them that you want to lease his property to drill wells, you're basically locking up that asset. The landowner has to have a lot of trust that you're actually going to follow through on your commitments and drill the wells. And we were able to convey in part because of the local nature of the management team that we would really be able to follow through on those commitments.

AI assessment note: “they had very deep relationships with landowners in and around”

Q So the management team had wealth, but presumably not every employee in the company did. How did you think about over this long hold period, making sure that the management team could retain the people they needed to, to continue their growth?

A Well, ultimately every employee of Crown Rock was an equity holder. I mean, that was a big part of the overall compensation scheme that we had there. Well over 200 millionaires were kind of birthed from the Crown Rock investment. I think our CEO had a very keen insight relatively early on, which is that if you give someone a piece of equity, they will very often undervalue that if there's not an option to realize the value that's there. Relatively early on, we started offering to buy back the equity from the employees On an annual basis, we would buy it back at whatever our mark to market value was that we reported to our investors. And in the early days, LimeRock purchased a lot of those units back. We were able to invest around almost another twenty five million dollars in secondary purchases from various people that retired or other employees that just wanted to realize some level of liquidity. What you find when you do that is almost no one wants to sell. As soon as you offer the ability to sell it back, They can see that it has real tangible value. They could make the election to sell it and realize some cash, but it's very rarely that they would ever actually do that. And the senior management team would never do that, even though we wanted to put more capital to work all the time. It really was great for tying further alignment to the business throughout the entire emplo…

AI assessment note: “ultimately every employee of Crown Rock was an equity holder.”

Q How did you match the duration of your capital with what you were seeing in this long duration investment opportunity?

A Well, we had a fund that effectively ended. That fund concluded, came to an end, including its two option years in 2018. So we had to go raise an entirely new fund. I think it might be the largest continuation fund in the energy sector even still. It was certainly one of the big pioneers effectively in single asset continuation funds in the energy sector when we did it. But that was a big six, nine month process to get that done. Effectively The investment at that point in time was marked at a 20 X. So you really have to give a lot of credit to the investors that did come into the fund. I can certainly understand any investor that sold at that point in time. They've been in a fund for 12 years. They probably had a different CIO through that period and had a different capital allocation objective. So you can't really fault anyone for selling, but I think give a lot of credit to new investors that came in into almost a single asset fund at a 20 X ROI. To buy into the vision that we had that there was a lot of continued growth yet to come out of that asset. And at that point in time, we were producing a little under 40,000 barrels a day, and we had projections to get well over 150,000 barrels a day if we held it for another five years. We briefly got over 160,000 barrels a day right before we sold the investment. So the thesis that we had Going into the continuation fund, bore out…

AI assessment note: “So we had to go raise an entirely new fund... continuation fund”

Q What were some of those different decisions that management team was able to make because of the duration of the hold?

A We treated the land as if we were going to hold it forever. And as a result, we always wanted to develop it as if we were going to drill every well on it. And we knew that our cost of capital was high. We knew that the ability to go out and replace that land was effectively impossible. There's a finite amount of it. We had some of the best resource in the entire world. You can't just go out and recreate that land position. And as a result, we drilled the wells in a much more deliberate way over time. As a happenstance of that, also maximize the value for any new buyer that would come in and buy the asset. It didn't necessarily result in the best quarter to quarter production growth. In fact, it decidedly did not because that was never a consideration for us. It didn't result in the highest near-term internal rates of return on our Capital program, but over the life of an entire asset, I think we managed the asset to try to maximize the total amount of profit dollars that would come off of that asset over time. There are distinct trade-offs in there, and you can see how different companies would take different decisions based on the constraints that they face. If you're in the public market, you care a lot more about quarter to quarter performance. If your cost of capital is different, you would make a different decisions than the ones we made

AI assessment note: “we drilled the wells in a much more deliberate way over time”

Q In the early years, management teams executing on this, you've got a nice oil price environment to be generating a lot of cash flow. What changed to go from investing as you thought you would according to the model and it's working out to a longer duration hold?

A On average, we had a pretty productive oil price environment throughout the history of the investment. Oil prices averaged about 70 dollars a barrel through the history of our ownership of the investment. But there were three calamitous events along the way that really affected the trajectory of the business. I think the CEO of the business, whenever we talk about those calamitous events, he always likes to focus on the good that came out of those extinction level events. The first was the global financial crisis that occurred really within two years of making that first investment. And in all of these extinction level events, there were a lot of bankruptcies. In the oil and gas business. The really good thing that came out of the global financial crisis is going into it, oil prices were very high as a result of the China super cycle. Essentially, people were drilling everywhere across the US. I mean, there were 1800 rigs running in the United States at that point in time. Last week, there was less than 600 rigs running in the US. So there's been a dramatic drop in the aggregate level of activity in the US. But in Oil field services, the drilling and completion services that you need, the wireline services that you need to actually drill an oil and gas well. When everything bombed out as part of the global financial crisis, oil prices fell to 40 dollars a barrel, effectively fa…

AI assessment note: “there were three calamitous events along the way that really affected the trajectory”