Increased M&A activity could boost oil production

More mergers and acquisitions could be in store for the oil patch in 2018, experts say, boosted by oil prices at levels not seen in 30 months and a flurry of available acreage as companies focus on their very best plays.

But some are concerned that more acquisitions, especially in the US, could mean surging production on top of the record 10 million b/d of crude output that the US Energy Information Administration projects for next month, and 11 million b/d late in 2019.

And in a market that has been oversupplied with crude in recent years, which in turn dragged down oil prices, any large-scale trend that hints at new production volumes could pull prices even lower.

“Acquirers aren’t buying properties for the [proved developed producing reserves] associated with the properties, but rather are buying properties they can develop,” Jeff Munoz, partner in global law firm Latham & Watkins, said. “I definitely think you will see an uptick in production from properties being sold.”

When acreage changes hands, production usually does not remain the same, he noted. Instead, operators set to work improving perwell yields through efficiencies and better completion designs.

On the other hand, since sellers often dispose of acreage to meet their capital budgets, they may drill even more on their retained assets, since sales provide more capital to spend on them, Munoz said.

“I do think you are going to see more production come online, given the current movement in prices and the amount of M&A activity everyone is expecting,” he said.

Production is particularly likely to rise after acreage that has long been non-core to the seller changes hands, Greig Aitken, principal analyst for M&A at energy consultants Wood Mackenzie, said.

“In such cases, the assets often haven’t been attracting adequate capital in the seller’s portfolio, so drilling has been minimal,” Aitken said. “The buyer’s value proposition is based around applying more capital to accelerate development and production.”

FOCUS IS ON LARGER COMPANIES

Waning interest and lack of scale in private-operator consolidation could lead to greater public market merger and acquisition activity, Tudor Pickering Holt said in a recent note to investors.

“We do see value in scale as increased trading liquidity, greater negotiating leverage with service providers, general and administrative synergies ... could lead to higher capital efficiency for development,” TPH said.

And that could lead to greater asset values “for both acquirer and acquired,” the bank added. Higher oil prices could accelerate non-core divestitures at higher valuations than previously thought, TPH said, citing mid-size operators RSP Permian and Callon Petroleum as likely candidates for acquisition.

The most likely acquirers include larger-cap names such as Devon Energy, Continental Resources, Oasis Petroleum, Newfield Exploration, Chesapeake Energy, Apache, and Matador Resources.

Increased crude prices are a key driver for more M&A activity, Rene Santos, an upstream analyst at S&P Global Platts Analytics, said.

FISCAL DISCIPLINE WEAKENING?

But that also worries some analysts who see higher prices as a trigger to spend more and potentially jettison the capital discipline that upstream operators have recently pledged to maintain so that they aren’t caught over-leveraged if oil prices should drop.

“For the past six months, companies have been talking more about living within cash flow versus continuing to grow—namely, aggressive acquisition and drilling,” Santos said. “You see some evidence of companies becoming more disciplined with the slowdown of M&A transactions and also the relatively flat rig count despite higher oil prices.”

Last year, upstream deal spending worldwide was above that of both 2016 and 2015, Wood Mac’s Aitken said. Globally, 2017 saw 384 deals collectively valued at $143 billion, compared to 420 deals at $128 billion in 2016 and 334 deals for $137 billion in 2015.

“There was a real pickup in deal activity in second-half 2016, predominantly in North America,” Aitken said. “Coming into Q1 2017, there was a huge amount of activity in the Permian Basin and Canada. But in Q2, that sort of quieted down and second-half 2017 was quiet by comparison.”

Right now, there is a small amount of bolt-on transactions to bolster producers’ core portfolio holdings, said Latham & Watkins’ Munoz, who expects it to continue a while longer.

A pickup in acquisitions and divestitures “hasn’t quite started yet,” he said. “We’re probably two or three months from people deciding $60[/b] is the new floor where they can say they’ll hedge an acquisition’s production at that price.”

“They’re not 100% convinced this will be the new floor,” Munoz said. “Until things get going, you’ll see a lot of smaller deals where people are selling off fringe acreage.”

The other type of divestiture that might be seen is acreage that companies know they likely will not get around to drilling for many years, Ray Ballotta, partner, M&A services for Deloitte, said.

“You might also see companies evaluating their drilling inventory and saying, ‘I have 50 years of drilling inventory, do I really need that? Maybe if I sell the last 10 or 15 years of drilling activity, that will be a potential catalyst for deals in the Permian,” Ballotta said. “That may be a way to shore up your balance sheet and foster small deals.”