Lower valuations for independent oil and gas producers could set the stage for consolidation, according to some industry analysts. But the reality of low oil prices and a disciplined spending climate may make buyers hard to come by.
Applying a standard of $30,000 per flowing barrel of oil equivalent to oil-heavy independents shows many trading at "a deep discount," investment group Suntrust Robinson Humphrey Inc. said in a recent update on the sector. The price that an oil-heavy exploration and production, or E&P, company could get for its assets has crashed since September 2018 when it peaked at approximately $90,000 per acre in the Permian Basin, the firm said. Since then, prices have fallen to as low as $20,000 per acre in the Permian and $5,000 per acre elsewhere.
"Our conclusion is that a number of E&Ps are likely set up for consolidation given our belief that they are trading for less than organic leasing/private transaction values," Suntrust analysts Neal Dingmann and Jordan Levy wrote. "Given the low $/acre figures that virtually all of our names are trading at relative to recent transactions, we believe that not only the Permian, but also the Bakken and Eagle Ford particularly, are ripe for consolidation."
Among the companies Suntrust highlighted as potential takeover targets were Matador Resources Co., Carrizo Oil & Gas Inc. and Callon Petroleum Co., all active in the Permian. The firm said Marathon Oil Corp. and Whiting Petroleum Corp. could also be looked at by opportunistic buyers due to their low acreage values.
While the opportunity exists for a good deal to be made in the current price environment, finding someone willing to part with cash needed may be difficult. Suntrust suggested supermajors Exxon Mobil Corp. and Chevron Corp. may be the most likely to make a move for a Permian independent, given their recently stated desires to expand operations in the play. Finding another, larger independent looking to expand, however, may be a tough task, sector analysts said.
"While now seems to be the time for M&A given the depressed Permian valuations, I think M&A activity will languish until commodity prices improve and stabilize," Williams Capital analyst Gabriele Sorbara said. The reason for such pessimism can be seen in the stock underperformance mentioned by Suntrust: Companies that have made moves to acquire strong-producing assets, such as Concho Resources Inc.'s $9.8 billion acquisition of RSP Permian in March 2018, have been punished by investors more interested in free cash flow than growth.
"The years of going through cash flows and going to debt markets recklessly are gone, but investors have been a little bit burned over the years," Andrew Slaughter, executive director for the Deloitte Center for Energy Solutions, said in an interview. Instead of seeking growth, most E&Ps are attempting to reassure investors that they will live within their means and keep expenditures at a minimum, cutting into their opportunities to acquire. This changed approach to doing business is unlikely to change soon, Slaughter added.
"As long as there's price uncertainty coupled with the expectation that we're not going to have the price bubble of five to 10 years ago, I think caution, prudence, call it what you will, is the flavor of the times," he said. "For the foreseeable future, that's what companies will try to do."
Significant private equity investment in the independents producer space could increase pressures for consolidation, but Suntrust believes having public E&P companies trading at an average of approximately $10,000 per acre "presents an issue" for private equity investors seeking to sell their stakes.
"There are still numerous private-equity backed companies looking for exit strategies, many of which have looked to increase production over the last 12 months to make an acquisition more attractive," the firm said. Some equity firms have spent large sums of money to build up companies to be attractive to buyers, only to find a disinterested marketplace.
"With limited exit opportunities, we're holding on to these business longer … to make them more appealing to public investors," Jimmy Crain, a partner with Encap Investments LP, said at a winter NAPE conference in February.