ENERGEN EXCLUSIVE 💡 | At the time this article is being written the oil price stands $36.7 per barrel of Brent and $34.7 per barrel of WTI. As COVID cases are once again surging globally and nationwide lockdowns are imposed, the demand for oil is expected to drop. More bad news for oil companies…
On the positive side both OPEC and IEA energy outlook reports recognize that oil & gas would be more than relevant in the world energy mix until at least 2040. OPEC sees demand for oil peaking between 2040 and 2045 while IEA highlights the fact that without policy interventions there is no sharp decline in oil demand before 2030
Despite the consensus from energy experts that COVID will be an accelerator to energy transition and renewables deployment, the two reports are sending contradictory messages. And of course, OPEC will always be leaning towards oil but even IEA raises the lack of policies question as a barrier to oil demand decline.
If we are going to need more oil, we are going to need oil companies to be around
This was probably what some of the oil executives were thinking in the past month, where four significant mergers where announced in the upstream oil & gas space:
ConocoPhillips acquired the Permian champions Concho for $13.3 billion
Cenovus merged with Husky Energy for $10.4 billion
Pioneer acquired Parsley Energy for $7.9 billion
Devon Energy acquired WPX Energy for $6.4 billion
All the deals were announced in October and while they are subject to closure, October was by far the most active month in the M&A space for this year.
Is it wise to pursue large acquisitions during a downturn?
Being diplomatic; yes, and no. The oil & gas M&A sector has a reputation of value destruction and on valid grounds, in our opinion. Mega deals of the past like the Shell-BG merger, Exxon-XTO acquisition and the most recent Oxy-Anadarko merger were all based on much higher realized commodity prices. Unavoidably, this led and will continue to lead towards asset write-offs killing some of the deal’s value.
Supporting the “Yes” part of the answer is trickier. But also stands on valid grounds
If we look at the four deals highlighted above, we see one common point across all. All four deals are focused on specific resource types. Concho and Parley energy are pure-play Permian producers in the US L48. WPX has significant production in the Williston basin, but their Permian position still account for approx.70% of their 2019 production. Husky is slightly more diverse, having assets in 4 basins but still 80% of their production comes from the Canadian Western Sedimentary.
Why do these support the “Yes” part?
Well to start with the L48 deals (Concho, WPX, Parsley), it is the area where the most significant cost efficiencies have been realized in oil & gas. When the shale revolution started, it was estimated that oil from that type of reservoir required on average $80 dollars to breakeven. Today this figure is below $40.
Further consolidation between the acquired companies, elimination of overhead costs and synergies are expected to strengthen the cost position for the new entities. And as the definition of synergy suggests: the interaction of elements combined produce a greater effect than the sum of individual elements.
The Canadian deal (Cenovus-Husky) is more complex as it includes refining, but still the oil sands position of the two companies would benefit from economies of scale, efficiencies and knowledge transfer between the two.
The bad new?
Consolidation comes with a cost in human resource. Rumors around the deals already talk about 10-20% headcount reduction to come in the new merged entities. Yet another blow to the workforce of the oil & gas industry which has seen dramatic reduction and layoffs since 2014.
Switching back to the importance of surviving this wave
Oil would still be around our lives for sometime. The world needs multiple secure sources of supply to avoid price shocks that have led to economics recessions in the past. Improving cost positions is key for international oil companies if they want to compete with the national oil champions. In the long-run, oil production will be a game of the last man standing, or as John Keynes said, "In the long-run we are all dead…"