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Oil and Gas Investor Magazine

[Editor's note: A version of this story appears in the February 2021 issue of Oil and Gas Investor magazine. Subscribe to the magazine here.]


The Golden Age of shale M&A was a kind of swinger’s party for oil and gas prospectors.

Private equity firms, (thousands of) lawyers and public companies traded money for shale. Afterward, any actual parties happened elsewhere, out of earshot of those public companies.

Now, shale seems to have entered a slightly less lustrous Bronze Age. Brought on by the cabin fever of coronavirus lockdowns and the languishing market caps of public E&P companies, the Bronze Age is marked by Zoom calls, dwindling cash and no parties whatsoever.

But behold! Like the ancients scanning the sky for portents, large bodies are colliding in the observable M&A-verse. Recent mergers include Devon Energy Corp. and WPX Energy Inc.; Diamondback Energy Inc. and QEP Resources Inc.; and Pioneer Natural Resources Co. and Parsley Energy Inc.

What should be made of these massive combinations? Scale, friends. Scale. Scale is often cited among the celestial mechanics that inevitably causes mergers. And it may be that those companies and their investors are comforted by feeling stronger, safer and bigger. Markets are, after all, about feelings.

Or not.

Before its deal for QEP, Diamondback CEO Travis Stice said on the company’s November earnings call that “We do not need to increase our scale to further reduce our cost structure,” citing the company’s production, healthy balance sheet and inventory.

Stice further said that the company’s supply chain was fine and that “These facts should prove to investors that we have the scale necessary to compete in this industry.” Such justifications, he said, were “specious and self-serving.”


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But in the third and fourth quarters, Devon, Diamondback, Pioneer and others agreed to part (at little or no premium) with $15.6 billion of their stock for their respective dance partners.

As accretive deals go, these didn’t intuitively jump out as wallet fatteners. The annual synergies and savings ranged from $80 million to $575 million. Unless oil prices go back up, of course.

Moody’s Investors Service said in a Dec. 8 report that stock-for-stock, low premium deals were creating more durable companies that favored “the strongest.”

Others have opined that consolidated companies will exert more control over production growth as the oil and gas markets continue their recovery. To be fair, though, no one was planning to floor it with oil rigs any time soon.

As Moody’s noted, capital spending in 2021 is expected to continue at a level similar to last year’s misery brought declines of 40% to 50% in capex. For the run-of-the-mill E&P, capital access isn’t likely to improve. The risk of defaults among low-yield E&Ps remains high. The goal now, Moody’s said last summer, is to find a path across the current desert and stumble into 2022 with an oasis of recovered oil prices.

So, could merging into even larger companies be somewhat akin to the bet once placed on the undeveloped resources that are, at current prices, roughly worthless?

No, Morgan Stanley said in a Dec. 11 report. The firm upgraded E&Ps to “attractive” and argued that a “regime change” was in the air. Analyst Devin McDermott cited oil company consolidation, rationalization of overhead and revamped management compensation among proofs that the industry has truly embraced free-cash-flow generation and put garbage production growth behind it.

“Over the past two quarters, E&Ps have broadly embraced capital allocation frameworks that constrain mid-cycle investment rates to 70% to 80% of cash flow and, in most cases, limit production growth to 5%,” McDermott wrote.

Well costs, he said, are now 20% below fourth-quarter 2019 prices—though it’s unclear if that’s due to a magic potion of efficiency or because service companies are hemorrhaging.

In 2021, McDermott predicted, the E&P sector will put 10 years of failure behind it and offer a yield of 11% free cash flow at $50 WTI.

Still to be resolved, however, are the icky problems of oil and gas declines. As Randy King, managing partner at Anderson King Energy, said in January, most of the significant profits in the upstream realm were made by entrepreneurs who bought low, did a little proving up of acreage and then sold at a higher price. This was largely during the Golden Age.

The sweet spot today is for long lived, conventional oil and top tier oil shales, predominantly the Permian Basin, he said.

“Having reviewed thousands of shale decline curves, I still don’t see any real science in choosing b-factors and terminal declines,” King said.

Whatever. Decline curves are in the future. Devon stock is up by 55%, Pioneer by 57% and Diamondback 47% since their announced mergers.

Enjoy this, the Bronze Age of M&A.