The shale revolution of the previous decade began with mantras of “drill, baby, drill,” interspersed with “spend, baby, spend,” and “buy small, grow fast, sell big, make money!”
That didn’t work, as the resulting river of shale oil flooded the market and crashed prices. Only a lucky few made big money on that plan.
Now the market has matured, while most or all economically viable reserves are known and in production, and investors are looking for predictable returns on cash and economies of scale, not on risky schemes.
Because of that, the last 18 months have seen a rush of mergers and acquisitions (M&A), amounting to around $250 billion worth in just the last year, according to figures from Enverus Intelligence Research (EIR). Here, Whitley Penn’s Audit Partner, Audit Energy Industry Leader Justin Roberts, Principal Analyst at EIR Andrew Dittmar, and Strategy and Transactions Energy Partner for EY, Bruce On, weigh in with how investors are driving the M&A flood, whether there will be consolidation afterwards, and what’s in the offing for 2025.
What’s Driven These Mergers?
Economies of scale and the maturing of basins, including the Permian, are among the main drivers, points on which all three experts generally agreed.
EIR’s Dittmar said, “I think what investors really prefer is that you have in-basin consolidation. And you find operational synergies, being able to more efficiently develop the assets, drill longer laterals, make more efficient use of available pipeline capacity,” he said.
A key motivation for him involves a low-cost operator buying a higher-cost company, “Then they’re able to reduce those costs to be more in line with their corporate average from an operational perspective.” As an example, he cited Diamondback, a low-cost operator, “they can go out and buy a deal and have a good chance of improving the cost structure, making those new assets more economic.”
While efficiencies are pushing many to the Permian specifically, EY’s On sees that concept spreading elsewhere as well. “What we’ve actually seen is continued activity in the M&A landscape, where we’ve seen acquisitions and mergers happening for other operators in other basins,” On observed.
On the inventory side, it’s somewhat akin to what Mark Twain said about land in general: “Buy land. They’re not making it any more.” In a century-old field like the Permian, “they’re not making it any more” could be true of produceable prospects. Dittmar noted that, while there is still a lot of general inventory, the “good stuff” is in short supply—and that high quality inventory is important for companies to maintain their capital efficiency. “So a lot of this M&A is focused on acquiring the highest-quality available inventory, and most of what’s been available is in the Permian, which is why it’s so central to these deals,” he said.
Still, he pointed out, some middle-tier inventories are getting at least some interest from those who missed out on the bigger deals. “All the available high-quality inventory… is rolled up in the portfolios of Exxon and Conoco,” and investors know that the tier II inventory will eventually gain value when it’s all that’s left to drill.
Are We Done? Not Just Yet
Justin Roberts
“Every time I’ve thought we were done, another large merger gets announced,” said Whitley Penn’s Roberts, adding, “There’s still some pretty big private companies out there, especially in the Permian, that could be acquired by some of the publics, still.” That might happen in 2024, or possibly in 2025.
After all, “The Permian is where everybody wants to be.”
Dittmar agreed, saying, “I think it’s lived out beyond our expectations, just given the tremendous buyer appetite for these assets and the premiums they’re willing to pay, that they’re willing to underwrite in terms of total asset value, is encouraging more and more companies to come to the market.”
Still, the big flurry of activity may be winding down, Roberts said, believing that the very biggest deals have been done. As examples, he cited the ExxonMobil/Pioneer deal and “even” the Endeavor/Diamondback merger.
Generally on the same page, Dittmar cautioned that M&A still has at least some life. “We are hitting a sort of inflection point. We’re past the halfway point of this particular consolidation cycle. So I think, in terms of this really heightened deal value, there are some pretty notable transactions still to go.”
And, Roberts believes, some further activity could be fueled by interest rate drops that have been hinted at for Q4 of this year. He pointed out that “usually, acquisitions are done with some debt in mind, so that [lower interest rates] change your rate of return and your acquisition model. So you may see some uptick when rates come down,” especially if the drop is at least three quarters of a point. Activity could come as soon as Q4 2024, or Q1 of next year.
Breath-holding over interest rates is accompanied by the same situation for the November elections. A Democrat sweep of the White House and Congress could forebode some curtailing of energy activity for the future, possibly causing some buyers to wait until Q1 2025 to evaluate an acquisition’s possible long-term value.
Two factors could engender a significant, though smaller, second wave. Non-operators are one possibility, said WhitleyPenn’s Roberts. “Maybe we’ll see some big deals in some of these non-ops coming together, or some of these large mineral companies that have had their investors in there a little longer.” Elections and interest rates are involved here as well.
A second wave could also come from gas plays outside the Permian, said EIR’s Dittmar. Through most of the last 18 months, gas prices have alternated between low—and lower. But the expected opening of several liquified natural gas (LNG) export terminals could change prices for the better.
As that happens, “I think there’s a fairly large bucket of potential gas sellers that have held on thinking they’ll get better value for their assets in 2025 and 2026, and if we do see a rally in gas prices next year, that could encourage more of those companies to come to market, and we could see an uptick in gas-focused M&A.”
Dittmar sees the rise of U.S. exports as creating “a shift in the market, where you move towards this more globalized gas market as opposed to regional gas markets.” Domestic gas markets may also expand, with “all the artificial intelligence [AI] and the associated datacenters that are coming online, and increased gas demand because of the amount of power that’s burned in those.”
Spinoff Activity
Bruce On
Another small but significant list of transactions involves some of the buyers spinning off assets they consider to be non-core, which ExxonMobil and others have looked into. Said On, “But what’s happening is a lot of these combined companies are now re-looking at their asset portfolio, and they’re taking the opportunity to really define strategically what is core vs non-core. And they’re trying to move quickly to divest non-core so they can keep their capital allocation.”
Assets to be sold are mostly those deemed “disadvantaged,” On said. He added, “Whether that’s a cost structure issue or a developmental play. So we expect, and are already seeing, activity carved out of these assets that have been taken to the market to be sold.”
Dittmar sees this activity as being relatively small, however. “I don’t know that it’s going to be a massive wave like you might’ve seen earlier in the consolidation cycle.” This clinging action goes back to the Twain quote. “That’s just because buyers are really keyed in on controlling as much high-quality inventory, and overall inventory, as they can. The outlines of the major North American shale plays are fairly well delineated, so there’s not a lot of opportunities to go out and organically add resources. You don’t want to sell something today that you’re going to have to buy back at a higher price 3-5 years from now,” Dittmar said.
Dittmar and On agreed that there are plenty of buyers, with the election/interest rate caveats as noted above.
Private equity money could fund many of those sales, Roberts added. “There’s a lot of private equity money out there chasing deals. There’s four of the five mid-to-large private equity groups that are exclusively in the energy space, that have raised funds over the last 18 months. So they’ve got a lot of capital to deploy, and they’ll be hungry to go get some deals done.”
The Changing Role of Private Equity
As PE money was behind much of the last decade’s “drill baby, drill” mantra, its role has now flipped, said Dittmar. “Traditionally, their role was that they were willing to take a gamble on less-proven acreage, and had a little bit higher risk tolerance and higher return requirements than the public operators. So they would do a step-out, test some additional intervals.” If that worked, they could then sell the assets at a profit. And over the last two years, he said, PE’s have been “massive sellers.”
But with shale plays becoming better defined and technology improving economics for most areas, there are fewer new resources to test and develop. “So they’re changing their business model to instead of being on the frontier of development, they’re revisiting some of these older legacy assets that may be shed by public companies. They’re managing from more like a yield perspective for their investors,” he said.
In short, the raging flood of M&A may have reached the tipping point, but it may never be over, as technology continues to improve production on all prospects, and as producers continue to maximize their investors’ cash flows.
Paul Wiseman is a freelance writer in the energy sector.
The post Life in the Merge Lane appeared first on Permian Basin Oil and Gas Magazine.
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