Industry built on risks is taking fewer of them
Investors favor stern discipline, cooling fervor for acquisition deals and big gambles in the energy sector
By most measures, the U.S. oil and gas industry would appear ripe for consolidation. Rising costs, modest oil prices, too many small players and a drive for scale and efficiency should add up to a flurry of mergers and acquisitions.
Instead, M&A activity has almost ground to a halt after a flurry of deals last fall. In part, the collapse of oil prices at the end of 2018 cooled the fervor for acquisitions. But a more fundamental shift appears underway as an industry built on risk-taking increasingly steers clear of big gambles.
The shift is driven by Wall Street, where investors have lost
patience with energy companies rolling the dice in pursuit of growth rather than restraining spending, maximizing profits and generating returns. The few companies that have moved forward with mergers and acquisitions — no matter how compelling the rationale — have been battered mercilessly by stock markets.
Despite winning plaudits for outmaneuvering Chevron in the David-and-Goliath bidding contest for Anadarko Petroleum, Occidental Petroleum of Houston has lost nearly 25 percent — or
$12 billion — of its stock market value since its pursuit of The Woodlands company became public in April. Chesapeake Energy’s market value has plunged more than 50 percent since the Oklahoma company
made the deal to acquire WildHorse Resource Development of Houston in late October. So has the value of the Canadian firm Encana Corp. which acquired the Houston oil and gas company Newfield Exploration at the beginning of November.
“They’ve all been punished, so I don’t think that gives anyone a warm and fuzzy feeling to go out and do a deal,” said Jennifer Rowland, an oil industry analyst with the financial services firm Edward Jones. “That (spending) discipline is what investors want to see. M&A runs the risk of destroying that message.”
M&A wave turns to trickle
As the land rush in the booming Permian Basin largely ended after 2017, leaving few acres unspoken for, the expectation was that bigger companies would gobble smaller ones as they sought to expand holdings in the prolific West Texas shale field. Those expectations were met — for awhile.
The third quarter of 2018 saw about $33 billion in deal-making among oil and gas producers — the most active quarter since 2012, according to the Austin energy research firm Drillinginfo. That slowed to $19 billion in the fourth quarter, which is about average for the industry.
But following the 45 percent plunge in crude prices at the end of last year from about $76 a barrel to less than $43 — oil industry deals slowed to a trickle, just $1.6 billion in the first quarter, the lowest amount in a decade.
Activity rebounded the the second quarter with the $38 billion Oxy-Anadarko deal, but other than that, merger and acquisition activity was weak. Only $7.6 billion in other deals were made in the second quarter, which ended in June, and some of those top deals focused on the slowly rebounding deepwater Gulf of Mexico, rather than shale.
“Oxy was more willing to go out on a limb than others,” said Andrew Dittmar, an analyst at the Drillinginfo. “Most companies are in retrenchment and battening down the hatches. Who’s ultimately right? I don’t know.”
Oxy management now finds itself in the middle of a proxy war launched by famed investor activist Carl Icahn to replace much of the board. Icahn has argued that Oxy played fast and loose with its shareholders’ dollars in chasing the Anadarko deal. Oxy is betting its approach will prove its value in the long term by expanding its Permian holdings and creating a scale of operations that will create efficiencies and cost savings.
Oxy is not the only company contending with a proxy battle that grew from an acquisition. Earlier this month, a proxy fight for Pittsburgh natural gas producer EQT Corp. led to the ouster of the CEO and most directors by dissidents who argued the company had lost financial efficiency after buying rival Rice Energy in 2017 for $6.7 billion.
‘Show me’
The environment for oil and gas companies, let alone those looking to spend big and take on debt to finance mergers, is far from hospitable. Despite the stock market rally that has lifted the S&P 500 Index 6 percent over the past year, stocks in S&P’s Energy Index are down more than 15 percent during the past 12 months. Skepticism about the industry, particularly the shale segment, is on the rise after years of lackluster returns .
Exploration and production companies have been hard pressed to realize any stock appreciation at all. Even the shares of ConocoPhillips, the Houston company that has won Wall Street praise for its spending discipline and focus on returns, are down about 13 percent over the year.
“Wall Street is very much in a ‘show me’ mode in shale,” said Dittmar. “They pumped a lot of money in and they’ve sort of run out of patience.”
The amount of money that Wall Street is willing to put into energy companies is down sharply. In the second quarter, money raised from stock and debt offerings fell 35 percent from a year earlier to $17 billion, according to Drillinginfo.
Investors were battered by the oil bust and smacked again when oil prices dove at the end of last year. While crude prices have rebounded of late to almost $60 a barrel — relatively healthy, but hardly bullish — fears are growing of a building global supply glut next year as demand growth slows along with the economy.
Some smaller acreage deals are continuing, but the only sizable corporate acquisitions apart from Oxy are coming through so-called merger-ofequal deals that combine similarly sized companies and share the risk, rather than having just one company put itself on the line. Other deals have been financed by individual billionaires, such as Dallas Cowboys owner Jerry Jones. His firm, Comstock Resources, recently paid nearly $1.6 billion to buy another company, Covey Park Energy, that operates in the Haynesville shale straddling the Texas-Louisiana border.
Merger-of-equals deals include oil and gas producer Amplify Energy of Houston combining with Midstates Petroleum of Oklahoma and Houston oilfield services firms C&J Energy Services and the Keane Group joining forces. Another merger of equals over the past week combined two Houston exploration and production companies, Callon Petroleum and Carrizo Oil & Gas.
The combined Callon will have greater Permian acreage with more scale and the ability to drill wells more efficiently, allowing it to better compete with bigger players, said Callon CEO Joe Gatto. “Mergers of equals are important right now,” he added.
While dealmaking is muted, it’s not dead, said Pavel Molchanov, an energy analyst with Raymond James in Houston. Most deals, he said, will aim at acquiring oil and gas producing acreage rather than entire companies.
The biggest acreage deal of late occurred about a year ago when the British energy major BP paid $10.5 billion to acquire the Texas shale assets of the Australian mining company BHP. With its Big Oil status and ability to pay in cash without taking on much more debt, BP wasn’t punished for its big move.
When corporate acquisitions do happen, the buyer’s stock typically falls at first because the company is paying a premium on the value of the company it is acquiring. It can take years for a sale to prove its worth, said Molchanov, adding “That doesn’t mean M&A is wrong.”
The next question is when the other top companies will start buying to expand their shale holdings. Exxon Mobil, Royal Dutch Shell and Chevron, as evidenced by its desire to buy Anadarko, are all considered potential acquirers. Several smaller and mid-sized companies have unofficial “For Sale” signs out.
But with a darkening outlook for 2020, no company wants to be condemned on Wall Street for overpaying, not even Big Oil giants. That’s why Chevron walked away from Anadarko and investors bid up Chevron stock after it let the deal go.
Consolidation in the Permian may be inevitable, but it may have to wait for both a healthier oil and M&A market.
“There’s a lot of companies in the Permian that are neighbors, doing the exact same thing and competing with each other,” said Dittmar, the Drillinginfo analyst. “It makes a lot of sense for there to be more consolidation. It just hasn’t really happened yet.”