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New Kind Consolidation Vital to E&Ps’ Survival

Source: Natural Gas Intelligence, November 2, 2020

The long-expected consolidation wave in the US oil and gas sector has begun, but this great defragmentation of US shale assets will be different from previous cycles. Rather than larger players boosting production, this round of mergers should keep gas drilling in check and reduce associated gas volumes, potentially keeping a floor under wellhead prices for years.

It might also be the final cakewalk for many fossil fuel producers as they hunker down for a midcentury reckoning.
“E&P companies are focused on free cash flow and cost-cutting because commodity prices have been so poor and because banks have reined in credit,” East Daley Capital Managing Director Ethan Bellamy told Energy Intelligence. “They are downsizing, prioritizing and triaging. Part of that process naturally leads to consolidation.”

Heightened M&A has already been playing out on a world stage, but is now moving into US oil and gas shales with increasing speed as financial stress-induced consolidation accelerates.

Just last week in Appalachia, EQT announced it was buying Chevron’s upstream and midstream gas holdings in the Marcellus Shale for $735 million, further solidifying EQT’s dominance in the core of the southwest Marcellus. In the Permian Basin, ConocoPhillips agreed to buy Concho Resources in an all-stock deal valued at about $9.7 billion. Other recent, notable deals include Chevron’s purchase of Noble Energy, which closed in October, and Devon Energy’s announced acquisition of WPX in late September.

Periods of consolidation following expansion booms,  like that seen in US shales in 2018-19, are not unusual.  But there is something fundamentally different about what is unfolding today for both gas- and oil-focused companies, said Abhi Rajendran, Energy Intelligence head of market research.

“What you’re seeing is a redefinition of what is driving economies of scale,” Rajendran said in an interview last week.

“All the M&A leading up to last year was based on the old scale mantra about having more inventory and growing faster and longer. The downturn has shaken things up with a new definition of economies of scale, which is all about being able to drive more efficiencies so you can be more resilient throughout a down cycle,” he said. “At the end of the day, it’s all about lowering your breakeven costs of production, whether you are oil- or gas-focused.”

Consolidation is also being driven by a new market dictum that size matters, he explained. “It’s pretty clear that the investor community has drawn the line with a company that has a $4 million-$5 million market cap and said anything below that is basically irrelevant,” Rajendran said. “Yes, it’s about costs, it’s about lowering your break-evens, it’s about finding those efficiencies. But it’s also about being big enough to be relevant.”

That can be especially critical as climate consciousness increases the pressure on the oil sector, “with a little more leeway for gas.”
As oil use is seriously curtailed in the coming decades, sector consolidation will create more financially resilient companies while slowing the pace of oil and associated gas growth, Rajendran said. “There is the sense that gas has this runway of growth that is still left whereas oil is definitely kind of seen as this — I don’t want to say the next coal but kind of heading in that direction.”

M&A Trend Seen Continuing

“Because the Permian is the best US oil province, it remained the last holdout for optimists,” Bellamy said of the latest M&A wave. “But Covid lockdowns and attendant demand destruction have beaten down even the most optimistic oil industry stakeholders.” 
As the US oil price struggles to break north of $40 crude — a price “woefully insufficient … to sustain and grow US oil production”