After last year saw some huge deals in the U.S. shale space, with ConocoPhillips merging with Concho Resources and Chevron buying Noble Energy, among others, it looks that this year will see a continuation of the M&A trend. Indeed, it is likely that consolidation is the only way forward for the industry. "It's a better way to ride through the cycles in our business," said the chief executive of Cimarex following the announcement of its all-stock merger with Cabot Oil& Gas Corp earlier this month. "The demands of our sector, in terms of returning free cash flow to our owners, [tell us that] these swings in our cash flow are poison, and this is just a wonderful antidote to volatility," Thomas Jorden said as quoted by the Wall Street Journal.
Shale oil shareholders have indeed become more demanding about returns lately, and the pandemic-driven crisis that shook the industry last year only served to sharpen these demands and prompted shale companies to reorganize their priorities. This time, unlike last time, they seem to be willing to stick with the new agenda. But it requires further consolidation.
During the last downturn in 2014 to 2016, shale producers also promised to rein in production growth and return more cash to shareholders. But as soon as prices began to rebound, growth was once again number one on their priority lists. This is no longer the case. The recent slump was much more severe, and this time, there is additional pressure on the industry from the energy transition camp that is changing the makeup of energy companies' shareholders.
For now, activist shareholders vying for board seats to make oil and gas companies mend their ways and stop being so much about oil and gas are targeting the supermajors. However, it is only a matter of time before they spread to independents, too, as the energy transition agenda reshapes the whole investment business. This will only add to the challenges of U.S. shale oil, among them costs and production control.
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Five years ago, it was all about production growth, whatever the cost. Now, the shale industry has learned its lesson, although it learned it the hard way with a flurry of bankruptcies. Pumping at will with no restraint can make an oil demand crisis that much worse. So now, shale producers are learning to control their output. One hurdle in the way of this control is the presence of small shale drillers who won't play along because they simply cannot afford it.
The industry needs a further consolidation to reduce the number of small independent drillers who have been adding rigs lately, said Pioneer Natural Resources' chief executive earlier this month on an earnings call. He wasn't delicate about it, either.
"I hope other privates are taken out that are growing too much," Scott Sheffield said as quoted by Reuters, referring to small private shale companies that began adding rigs the moment prices got high enough. Yet this is undermining the production control efforts of their larger sector players such as Pioneer. The company has been pretty active in the dealmaking business, buying Parsley Energy last year for $4.5 billion and DoublePoint Energy this year for $6.4 billion.
Consolidation is the optimal way to address all the significant challenges that the industry faces. Mergers tend to lead to cost reductions, improving free cash flow prospects. They also help optimize production to respond to actual demand rather than hopes for demand. At the same time, consolidation takes care of those pesky small players that produce as much as they want even if it hurts prices—and as a result, the stocks of the big fish in the pond.
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Last year's consolidations started late, possibly because the shock the industry suffered from the pandemic-caused demand destruction was unprecedented. But since then, dealmaking has been gathering speed with some, such as energy consultancy Enverus, expecting more deals this year. That's despite higher valuations thanks to higher oil prices, which resulted in record cash flows for shale drillers.
Forecasts about profits are helping fuel the trend, too. Rystad Energy said earlier this month that U.S. shale drillers could rake in pre-hedge revenues of $195 billion collectively this year. Of course, this is contingent on several factors, including West Texas Intermediate remaining at about $60 per barrel and natural gas and LNG prices not declining substantially, too. Still, the forecast is upbeat enough to whet investors' appetites for acquisitions in the shale space.
Not everyone is sold on the acquisition trend, though. Marathon Oil, for instance, recently said that it was going to pass on acquisitions to focus on investor returns. The way the company put it was that it was not going to "indulge in expensive" dealmaking, as carried by Reuters. This hints at higher business valuations, which would eventually put an end to the M&A wave. It also hints—more strongly—at the new number-one priority for shale drillers: shareholder returns, not production. As long as mergers and acquisitions are good for shareholders, they will continue.
By Irina Slav for Oilprice.com
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