Why the fluidity of energy markets is pushing shale companies to merge
More than forty American oil and gas companies went bankrupt this year
The long-awaited consolidation of the US shale oil and gas industry seems to have arrived. In the space of a month, $23 billion of acquisitions have been announced. This heralds a more resilient but less dynamic shale business – a welcome development for competitors, including Opec.
In July, Chevron agreed to acquire Noble Energy for $13bn, though motivated more by the target’s new gas fields in the eastern Mediterranean than its US holdings.
The more recent deals have been pure shale. Devon bought WPX for $2.56bn last month. ConocoPhillips offered $13.3bn for Concho Resources last Monday, including assumption of debt. The merged entity would be the largest independent company in the world, producing 1.5 million barrels per day of oil and gas - as much as the whole of Oman.
Pioneer Natural Resources plans to pay $7.6bn for Parsley Energy on Tuesday. An interesting twist here is that the outspoken Scott Sheffield, something of a spokesman for the shale industry, is Pioneer’s chief executive; his son Bryan is founder and chairman of Parsley.
Finally, the biggest US gas corporation, EQT, is reportedly in talks to acquire rival CNX.
But these are not the empire-building, ego-driven swoops of yesteryear. Would-be acquirers have been burnt by the example of Occidental, which bought Anadarko for $38bn plus taking on $19bn of its debt in August last year. Since then, oil prices have collapsed and the pandemic has struck. The combined entity now has a market capitalisation of just $9.5bn.
Instead, the latest crop are all-stock transactions at low premia to the target’s depressed share price: 4 per cent for WPX, 15 per cent in the case of Concho. They are primarily defensive, building scale, cutting costs and aiming for synergies from combining adjacent acreage. Parsley and Pioneer, for example, both operate in the Midland area of the Permian basin in west Texas.
But they also have optionality to boost output in future if overall US production declines and oil prices rise, a scenario that the ConocoPhillips chief executive, Ryan Lance, cited in justifying the Concho deal.
To reassure investors, companies are committing to variable dividends: a base payout plus an extra amount dependent on available cash. That preserves financial flexibility while signalling that companies will not follow the old model of burning all surplus cashflow and more on new drilling.
Are more deals on the way? Mr Sheffield (senior) believes that Pioneer-Parsley, EOG, ConocoPhillips and “maybe” Hess will be the big independent shale survivors. EOG, the biggest pure shale oil firm of all, which recently made a surprising foray into Oman, could be a buyer but does not have to. Marathon Oil and Apache, on the other hand, need to build scale.
Diamondback is the biggest remaining listed target for an acquirer; Ovintiv and Cimarex are other candidates, along with a couple of privately-held firms. Outside the Permian basin, Whiting Petroleum and Continental Resources in the Bakken formation of North Dakota could tie up.
But acquirers will be very selective. In the current tough environment, no-one will burden themselves with a heavy debt load, excessive costs, mediocre geology or more negative cashflow. More than forty American oil and gas companies have gone bankrupt this year. Though as prize-winning oil historian Dan Yergin reminds us, “rocks don’t go bankrupt”, it will take rising oil prices or cuts in production costs to interest companies in drilling again.
The current merger phenomenon is reminiscent of the 1990s. Then, the major oil firms expanded capacity at the expense of profitability in the North Sea, the newly accessible former Soviet Union, and Opec countries that reopened to international investment, notably Venezuela and Iran.
But in the late 1990s, as oil prices tumbled to $10 per barrel, a wave of consolidation reduced thirteen majors and several big independents to six new “super-majors”.
The new companies focussed on cost cuts and capital discipline. The resulting shortfall in investment helped set the stage for fears of peak oil supply and the dramatic surge to the all-time price record of $147 per barrel in July 2008.
When Opec boosted production in late 2014 even as the oil price crashed, and again when Saudi Arabia and Russia vied for market share this March, some interpreted their behaviour as an attempt to kill off the American shale industry. But even if possible, this was not the aim – and shale in any case proved much more resilient than expected. Instead, Opec wanted to limit shale growth – to prevent it from expanding at 1-1.5 million barrels per day each year and taking market share from established producers.
Now a raucous mob of shale independents, hungry for growth at any prices, is being thinned out to a grizzled pack of survivors. Leading oil services firm Baker Hughes forecasts US oil production will fall next year as well as this, as companies cut reinvestment to a minimum. Shale producers’ output will drop 30-40 percent annually without significant new drilling.
That is overall good news for Opec. The new pool of companies will be more financially secure, more technologically capable and have a lower cost base, below $30 per barrel in the case of Conoco-Concho. But unless prices shoot up high enough to trigger a renewed feeding frenzy, they should also be more disciplined, prioritising profits over production. A shale industry that grows moderately when prices are high and falls back when they are low would encourage medium-term market stability, without forcing traditional producers into ever-deeper cutbacks.
With inventories still bloated and 7.7 million barrels per day of cuts to reinstate before even regaining 2019 levels, the Opec+ coalition will be relieved to see shale mature from a disruptive opponent into a predictable complement.
Robin M. Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis
Updated: October 25, 2020 03:49 PM