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Analysts predict increased M&A in oil and gas sector despite recent history

For the past half-decade, hoping for an increase in M&A activity in the upstream oil and gas sector has been a cycle of disappointment. When the calendar turns, there is a surge of optimism that "this is the year," only to see the same uninspiring results at year's end.

However, recent history is not stopping analysts from anticipating big results in 2020.

Industry observers anticipated 2019 would be a big year for M&A despite promises from producers that they would exercise restraint, holding to the belief that consolidation was a necessity in major U.S. unconventional plays. Fearful of investor backlash, most producers stayed on the sidelines, even if Occidental Petroleum Corp.'s $57 billion acquisition of Anadarko Petroleum Corp. skewed the results. The pounding Occidental's stock took in the wake of the merger, coupled with minimal access to capital, appeared to justify the lack of interest in making large-scale acquisitions.

"Investors who funded the shale revolution over the last decade have become vocal in advocating for payouts and cut back on providing new capital. That flowed through to limited M&A and a negative reaction to deals for much of the year," Enervus senior M&A analyst Andrew Dittmar said. The Enervus analyst also said, however, that an increase in M&A activity in December 2019 should "bode well" for M&A in the new year.

Industry observers continue to assert that the Permian Basin is in severe need of consolidation, something Enervus restated in a Jan. 2 report. With private equity playing both sides of the fence as some firms are looking to sell out and cut their losses while others are trying to take advantage of depressed values, Enervus said M&A opportunities should increase. Another sign of a potential M&A increase: during the second half of 2019, smaller producers showed a willingness to accept lower buyout values as their funding options dried up, the firm said. That trend could continue into 2020.

SNL Image

The pounding taken by Occidental Petroleum after its $57 billion merger with Anadarko Petroleum may scare off major M&A activity, but analysts believe that there will be more deals in 2020.
Source: AP Photo

"Challenges for one company can mean opportunity for someone else and we're seeing that on the private capital side," Enverus market research director John Spears said. "During the exploratory and high growth years of shale, private equity was funding companies to drill and flip acreage. Today, private equity is providing a secondary source of capital to companies that need to grow but don't have the financial means via joint ventures, drillcos, purchasing overriding royalties, and other arrangements."

Part of Enervus' premise that M&A will increase is contingent on the idea that producers are prepared to turn their backs on changes they have made in order to appease investors and that those investors will allow them to do it with minimal blowback.

"After a year of cutting costs and focusing on efficiencies, larger companies look ready to turn the corner on free cash flow and are instituting dividends and share buybacks to reward investors. Their stock prices are also on the rise, aided by a combination of their own operational improvements and tailwinds from an improving global economic picture and rising oil prices," the firm said. "As investors grow more confident in a company's ability to deliver on free cash flow, they also become more open to acquisitions, provided asset quality is high and the price is reasonable."

In a late December 2019 note, SunTrust Robinson Humphrey said it believed that a "slew" of first-quarter 2020 deals could be on the horizon. Citing the positive response to WPX Energy Inc.'s $2.5 billion acquisition of Felix Energy LLC in mid-December 2019, the firm said it believed that investor sentiment could be changing. With crude oil prices around a "very economic" $60 per barrel, SunTrust said independents with solid balance sheets could be ready to expand, at least in a limited fashion.

"Looking ahead to 2020, we believe that most of the M&A we could see during the year will be targeted toward private equity-backed [exploration and production companies] as funds reach their 3-5 year exit horizon and concerns on full-scale development for smaller teams comes more to the forefront," the firm said. "We believe there are a select few of our covered names that could pursue larger-scale M&A with a positive market reaction."