The U.S. shale industry first went on a consolidation spree back in 2015 when prices tanked after Saudi Arabia turned the taps on full in response to growing shale output. Since then, the consolidation has continued, although unevenly.
But it is about to get an additional spur.
According to industry executives, the recent jump in price volatility will motivate more companies to consolidate, especially in the Permian—the star among the shale plays. Another reason for further consolidation is the uncertainty about the future fossil fuels will have amid the renewable energy drive, the Houston Chronicle reported this week.
Indeed, there is reason to worry. Prices are already excessively volatile with the continuing pandemic, the absence of evidence that mass vaccination is creating herd immunity, and the emergence of the new Omicron variant, which has rendered the herd immunity question moot. In fact, the industry is now beginning to suspect that prices could rise too high.
"I'm worried that it may get too high, above $100 (per barrel)," Pioneer Natural Resources' Scott Sheffield told Reuters in an interview at the World Petroleum Congress. "I hope it stabilizes between a $80 to $100 range over the next several years. We need stability in the oil markets."
Consolidation is one way to achieve stability, as you would have fewer players in a field and, as a consequence, fewer differing views on what the right level of oil production is. To illustrate, research from IHS Markit earlier this year indicated that U.S. shale oil production was on the rise despite large companies' reluctance to return to a growth strategy. It turned out production was rising thanks to small private independents that had no shareholders to return cash to.
"Consolidation of our industry is a force that is not going to slow down," said Tim Leach, former chief executive of Concho Resources, which Conoco acquired earlier this year. "I think our industry needs to be consolidated. There are benefits to having size and scale," he added, as quoted by the Houston Chronicle.
These benefits include leveraging economies of scale and becoming more competitive even at lower oil prices, although few seem to be expecting lower prices anytime soon. Larger companies can also more easily get funding from banks, Chron's Paul Takahashi notes, although this may be changing before too long as ESG pressure increases on lenders to cash-starve oil and gas projects.
Besides these benefits, there are better and worse times to grow through acquisitions and now happens to be a better time: the oil price rally relieved companies of much of their debt and this, according to Pioneer's Sheffield, "gives you options."
"That's why we took advantage of the marketplace in the last 18 months to make two large acquisitions. I think you'll have another cycle of consolidation over the next three to five years," he told the Houston Chronicle.
The U.S. shale industry is projected to spend a combined $18.4 billion next year, according to Rystad Energy. That's 19.4 percent more than what it spent this year. However, half of the increased expenditure will be due to cost inflation, which will account for as much as $9.2 billion of the combined 2022 spending bill.
That's one more reason for mergers and acquisitions in the shale patch, especially since the outlook on inflation remains quite gloomy, especially with the Federal Reserve seen to end its stimulus program by March next year and start hiking interest rates, which will be the beginning of the end of cheap financing.
These expected developments, on the other hand, could also lead to a slowdown in the acquisition spree in the shale patch. Enverus, for example, expects a slowdown because potential buyers are simply running out of acquisition targets, the Chronicle reported this week. Company valuations are also on the rise along with the price of oil, and with the Permian still considered the sweetest spot in the shale patch, drillers with exposure to it would be the ones with the biggest valuation gains.
In this situation, there are two things potential buyers could do: take a break and wait and see where valuations go next, or put more money into acquisitions with long-term uncertainty still hanging over the head of the industry.
The wait-and-see approach could save buyers money and exposure to assets that may become stranded if the green transition gathers pace. Or it could make them miss opportunities that will never be as sweet again if bullish oil price forecasters are right.
The splurge approach could be costly but give buyers access to a greater resource base at a time when there's worry about underinvestment in new oil production, despite the green push. It is not an easy choice to make, especially amid the ongoing pandemic, but it may be a choice some shale companies need to make.
By Irina Slav for Oilprice.com
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