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Highlights

Too many small, mid-sized companies

Oilfield services needs more consolidation

Services subsector still not making suitable profits

Houston — Consolidation through the oil and gas sector is heating up, spurred in many cases by too many small companies, lack of operator scale, profits and in the oilfield services segment, an inability to raise prices after the recent downturn, industry executives said Tuesday.

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Recent multibillion dollar deals in such diverse subsectors as upstream and oilfield services that provide producers with equipment and services have not only been thought beneficial, but analysts and industry watchers at the Deloitte Oil & Gas Conference say more are coming.

"They will have to [consolidate]," Roger Burks, CEO of WG Consulting, said of upstream shale operators on the conference sidelines, adding many companies are still not making free cash flow despite oil prices that have mostly been at or above $60/b most of this year.

And Doug Lawler, CEO of big independent producer Chesapeake Energy, whose company surprised the market early Tuesday with an announcement of its intention to acquire Eagle Ford Shale player WildHorse Resources for nearly $4 billion, told the conference that he believed not only will more mergers and acquisitions across industry happen, but he expected his own company, which in its early days grew by acquisitions, would be a player.

"There's a lot of smaller high-quality companies across industry where synergy and value can be captured" by combining, Lawler said. "This will be a part of [Chesapeake's] strategy going forward."

OILFIELD SERVICES SECTOR SEES NOTABLE CONSOLIDATION

The oilfield services sector is seeing some notable consolidation lately after an industry downturn when oil prices plummeted to average just below $50/b during 2015-17, down from over $100/b in mid-2014. For example, big offshore driller Ensco is acquiring big offshore peer driller Rowan Companies, while big deepwater driller Transocean is buying Ocean Rig.

While those are all large offshore players, there are dozens of smaller companies that cater to onshore customers and specialize in niches of the North American shale market. These operators offer services that range from pressure pumpers, rental tools, drill bits and fluids and a wide assortment of services involved in drilling and completing oil and gas wells.

"There is huge pressure on all oilfield service companies today," Steve Trauber, vice chairman and global head of energy for Citi Investment, said during a conference panel on financing and mergers and acquisitions.

Underpinning Trauber's remarks is the reality that oilfield service and equipment providers granted E&P companies discount pricing for the better part of the downturn. But while oil prices have risen, service providers are still not making the profits that should be expected at this point in the industry recovery.

"In an environment where we went from sub-$40/b to $70-plus oil, you'd think oilfield service companies would grow dramatically and earn tremendous economic rent, but today they're not," he said.

HIGH COST OF CAPITAL FOR SUBSECTOR

While the big integrated service players such as Halliburton and Schlumberger will not falter, "the mid-caps and small-cap players, there's too many of them and they have a very high cost of capital," Trauber said. "Banks tend to be reluctant to loan to them because of their cyclicality."

He believes that many of these companies are already looking for an exit, while others could have consolidation "forced on" them as they struggle to stay afloat even with higher oil prices.

"Ultimately there will have to be massive consolidation of those companies," Trauber said.

WG Consulting's Burk said he believes there will be more bankruptcies in the oilfield services sector as well.

According to Haynes and Boone's Oilfield Services Bankruptcy Tracker, 172 bankruptcies of North American service providers were filed since January 2015, as well as 160 bankruptcies by E&P companies.

At a time when the direction of commodity prices is uncertain and companies are in transition to new business models and corporate priorities, markets "clearly" want energy companies, especially upstream producers, to generate free cash flow, although that may constrain growth, Angelo Acconcia, senior managing director of The Blackstone Group, said.

"You've had maturation of the shale sector, and we're in the fourth, not the ninth inning of [that] ball game," Acconcia said. "Over the next three to five years, teams with great assets will see more consolidation, more interest and a scarcity premium."

On the other hand, "a lot of money is out there, private capital that wants to be invested," in the oil and gas sector, Andrew Calder, a partner at international law firm Kirkland & Ellis, which has an energy practice, said. "There must be 200 or 300 funds looking to get into the oil and gas space."

But at the same time, "one thing we're hearing is that small and mid-sized companies should consolidate to maximize profits," he said.

Hedge funds, for example, "don't believe in 10 companies with separate G&A" or general and administrative functions, Calder said, based on what he has heard from fund managers. "Instead of five companies trying to drill in a popular basin, you should put the five companies together and have one productive company. The current mantra is return capital or consolidate."

-- Starr Spencer, starr.spencer@spglobal.com

-- Edited by Derek Sands, newsdesk@spglobal.com