This month, after the merger and acquisition transactions in the oil and gas sector with a total scale of over 110 billion US dollars were completed, the atmosphere was filled with the smell of mergers and acquisitions. First, Exxon Mobil (XOM) reached a deal to acquire the Permian Basin giant Pioneer Natural Resources (PXD), and then Chevron agreed to acquire Hess. Who will be the next?
The transaction negotiations are already underway. According to Bloomberg, another top producer in the Permian Basin, Devon Energy (DVN), is reportedly focusing on targets including Marathon Oil and CrownRock. According to Reuters, natural gas producer Chesapeake Energy is considering acquiring Southwestern Energy.
In the prolific Permian Basin, with the continuous reduction of high-quality shale oil and gas reserves and the limited number of sizable targets, energy companies may soon be forced to take trading actions.
Dan Pickering, Chief Investment Officer of Pickering Energy Partners, said, "Among them, the fear of missing out (FOMO) will only intensify. If there are one or two more transactions, there may be a scarcity premium starting to emerge
According to data from Enverus, Occidental Petroleum, Devon Energy, and Diamondback Energy are among the largest producers in the Permian Basin, and their scale is large enough to be potential targets or acquirers. According to an analysis by Goldman Sachs, the resource lifetimes of all three companies are estimated to be 30 years or more.
Pickering also stated that although EOG Resources is also one of the top producers in the region, the company has always been more interested in asset acquisitions than corporate mergers and acquisitions. Small Permian producers with a market value of less than $10 billion include Matador Resources and Permian Resources, which agreed to acquire their peers Earthstone Energy in August.
ConocoPhillips (COP) may be another acquirer. Considering the outdated valuation of European oil giants and the pressure to reduce carbon emissions, they seem unlikely to participate in the bidding.
The time for market integration is ripe. In a white paper released in June, energy asset management company Kimmeridge pointed out that for US oil and gas producers, there are "too many listed companies" relative to the level of investor interest. After analyzing the regulatory announcements of five active fund management companies, including Fidelity and J.P. Morgan, Kimmeridge found that in the second quarter of 2023, compared to the same period five years ago, the shareholding ratio of these fund management companies in the five largest energy companies in the S&P 500 index increased from 40% to 53%. At the same time, the proportion of small energy companies held by these companies has decreased. In other words, energy companies with a market value below a certain level will not be given a glance by investors.
Therefore, the valuation gap between energy giants and small producers has widened. The current valuation of an index heavily weighted towards ExxonMobil, Chevron, and other large manufacturers (measured as a multiple of enterprise value relative to Ebitda over the next 12 months) is 44% higher than an index tracking small manufacturers. The average premium over the past 17 years was 14%. At the time when we were most optimistic about shale oil and gas plots, there was a period when the valuation of small hydraulic fracturing companies that had grown rapidly was higher than that of their larger and less flexible peers.
There are still reasons to believe that this wave of trading may not be so aggressive. Kimmeridge portfolio manager Mark Viviano believes that in many cases, stubborn executives and boards of potential target companies do not have the motivation to give the green light to transactions. In a previous report, Kimmeridge pointed out that the CEOs of most exploration and production companies hold very few shares directly, and their abilities are usually not transferable outside the industry, so exiting is not a popular option.
Viviano said, "The transaction between ExxonMobil and Pioneer is very eye-catching, and I hope it can serve as a catalyst, but I naturally hold a skeptical attitude
Betting on the next target is tricky, but a broader integration trend should be beneficial for energy sector investors as a whole. According to Robert Clarke, Vice President of Upstream Research at Wood Mackenzie, although ExxonMobil hinted that the production after the merger with Pioneer would actually increase compared to when the two companies remained independent, the number of drilling rigs has decreased in the past 18 months after other merger transactions were completed. As long as future integration leads to more such reductions, it should provide support for commodity prices and returns.
During the shale oil boom, the fear of missteps that plagued the growth of drilling companies was unhealthy. However, the fear of integration errors is worthy of applause from investors.