Ripe for Takeover
North American independents are hurting, but will Big Oil scoop them up?
The conditions are right for a new wave of mergers and acquisitions in North America. Large oil companies, with cash but fewer places around the world to spend it, are eyeing cash-starved independents overburdened with natural gas assets in a surplus market.
Transactions have begun. Large oil companies have picked off pieces of property over recent months, particularly in rapidly developing natural gas shale plays. Analysts say it’s a process that should accelerate as asset prices decline from the stratospheric levels reached less than a year ago.
North American natural gas producers, who have spent the last several years piling up prospects as asset values steadily increased, now face a double whammy: a surplus market with declining prices and nearly non-existent credit. Independents have hunkered down, cutting costs and capital expenditures to wait out the economic downturn, but that may not be enough.
Treading a different path, large oil companies are flush with cash but have been squeezed out of major resource plays around the globe by increasingly insular politics of countries intent on developing their own energy business.
Those paths are converging. Total U.S. gas reserves have grown for “nine straight years and U.S. gas opportunities are now scalable, even for Big Oil,” says Credit Suisse energy analyst Mark Flannery.
“Big Oil has a growth problem, for sure, but is extremely well capitalized, and we now see an M&A window opening,” Flannery says. The majors shrank their North American upstream businesses to move toward more attractive opportunities globally. “However, access to new resources has proven much more difficult than imagined. We think the recent de-risking of large new unconventional resource plays in the U.S. means that the relative attraction of assets held by some North American independent exploration and production companies has increased.”
Giant multinational producers, which include ExxonMobil Corp., Chevron Corp., Royal Dutch Shell plc, ConocoPhillips and BP plc, control less than 10 per cent of the world’s oil and gas reserves, he notes. Most of the proven reserves, or about 80 per cent, are held by national, state-run producers like those in Saudi Arabia and Venezuela. ExxonMobil, the world’s largest investor-owned oil company, produces only about three per cent of the world’s energy supplies, Flannery points out.
Meanwhile, U.S. gas producers “have become a temporary victim of their own success with production up nine per cent year-over-year or five billion cubic feet per day, pushing down gas prices below the equilibrium level of $8.00-8.50 per MMBtu. At gas prices in the mid-$7 range, most companies cannot maintain high production growth rates without external capital, now significantly more difficult to obtain.”
Unable to finance their growth, “we think some independent exploration and production companies are now vulnerable to, and potentially open to, a sale,” says the Credit Suisse analyst. “The long-term demand picture for U.S. gas is robust, led by continued growth in power demand, while the likely cost of [carbon dioxide] in the U.S. seems largely not priced into the gas futures curve. Those majors that believe in the longer-term convergence of North American gas prices with oil prices now have a chance to get involved at a decent price, we think.”
Jed Shreve, a principal with Deloitte Financial Advisory Services LLP, thinks as many as 10,000 U.S. producers of all sizes may be “well-placed” for consolidation. “It’s a very diverse group of companies,” he says.
Big Oil traditionally is not given to shopping sprees, even when their coffers are full. ExxonMobil, BP, Chevron, Shell and ConocoPhillips plowed around 55 per cent of the cash they made into stock buybacks and dividends in 2007, according to Rice University’s James A. Baker III Institute for Public Policy. The percentage spent on acquisitions has remained in the low single digits for several years.
However, “tighter credit and a further decline in oil prices could accelerate industry consolidation and establish a baseline for energy asset valuations, which could boost stock prices above our targets,” says Oppenheimer & Co. analyst Fadel Gheit.
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