Oil shock could temporarily stunt shale driller M&A – analysis – Analysis
13 March 2020
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• Leveraged companies such as Whiting, Chesapeake face fight for survival
• Occidental and Marathon scale back capital plans, leaving emerging plays unfunded • Federal intervention looms as possible salve The oil price shock this week could in the near term stifle M&A among shale drillers, a group that has seen little deal flow for years, according to two sector executives and an advisor. But it could open the door to more consolidation and distressed M&A further out.
“A month ago I thought deal flow was about to break loose,” the advisor said. “We’ve been living at USD 50 (WTI crude) for long enough that people were ready to accept it. Now, I don’t know. Everyone was already in survival mode.”
The energy sector saw little M&A activity for most of 2019. The US’s oil and gas exploration and production subsector accounted for 138 deals valued at USD 116.5bn in 2019, according to Mergermarket‘s deals database. The figure is inflated by Occidental Petroleum‘s [NYSE:OXY] USD 54.4bn acquisition of Anadarko Petroleum. Without that deal, the remaining USD 62.1bn is about 42% of the USD 145.9bn average annual deal value of the previous nine years.
WTI crude stood at about USD 31 per barrel Thursday night, down 43% from where it stood six months earlier. Much of that fall came in a precipitous 30% drop in crude prices on Monday after a threat from Saudi Arabia to flood the market with cheap oil — the largest single-day decline since 1991.
That drop has left highly leveraged companies in danger, the advisor said. Whiting Petroleum [NYSE:WLL] and Chesapeake Energy [NYSE:CHK] were two companies that stood out with high debt loads and large amounts of assets outside of the more lucrative Permian Basin that spreads between western Texas and southwestern New Mexico, the advisor said. Several private equity-backed companies could also face cash crunches, though the advisor did not name specific companies.
Several companies had already been teetering on the edge of bankruptcy, said one oil and gas executive. The nature of shale wells – strong initial production but rapid declines compared to conventional wells – requires constant drilling of new wells, resulting in a higher cost of production.
Larger production declines and higher expenses have led to insufficient cash flow to service loans, said the executive. As a consequence, banks have been pressuring companies to lower their debt by selling less economic reserves in basins outside the Permian.
The challenge is there are few buyers for assets in the less economic basins, and for the banks aiming to get out of reserve lending, no buyers for the loan portfolios. “They can’t get rid of assets,” the executive said.
It could take 18 to 24 months for oil prices to return to USD 50 per barrel, said the executive. Fifty dollar oil is a benchmark many drillers have used to determine the viability of projects since a 2014 oil price collapse that forced them to focus on living within cash flow instead of seeking rapid growth. In 2014, Brent crude prices dropped from USD 112 a barrel in June to USD 48 in January 2015.
A second executive said it is hard to justify spending on growth in the current environment, where oil demand is expected to fall in the face of the Covid-19 pandemic and promised production increases by Russia and Saudi Arabia are further suppressing prices. Gas production was already stifled by low commodity prices in recent years.
But the second executive also said the lower prices could serve as a catalyst for more M&A once people “get their wits about them.”
“Today, everybody’s in shell shock,” the executive said. “But give it a few months, people will come to their senses and realize the game has changed.”
Rob Woodings, CEO of Woodings Industrial, a Mars, Pennsylvania-based steel equipment manufacturer with a large concentration of customers in the shale oil and gas space, has noticed a segregation of companies resulting in a two tier market with obvious winners and losers. While some companies are struggling, others could benefit from the current market situation, he said.
“If you’re over-levered you are probably going to get hurt in all of this,” he said. “But if you’re someone like Exon Mobil or Pioneer Resources, you’re probably going to do alright because you’re going to pick up some assets that are on sale right now.”
The sector advisor noted that the oil price drop and the concurrent fall in stock markets has already led shale drillers to pull back on capital budgets. Occidental announced Tuesday it would cut its dividend by 86% and slash 2020 capital spending to between USD 3.5bn and USD 3.7bn from the USD 5.2bn to USD 5.4bn it had just announced in February. While Occidental did not announce which assets it would pull away from, the advisor said the most likely course would see it sink more money into the Permian Basin — recognized as having the best economics of any shale play in the US — and pull away from developing plays such as the Powder River Basin in southeast Montana and northeast Wyoming.
Occidental did not respond to a request for comment Thursday but did indicate in announcing the funding cut that it could break even with benchmark WTI crude in the low- USD30s per barrel.
Marathon Oil [NYSE:MRO] — which saw about two thirds of its domestic production come from the Bakken and Eagle Ford plays in 4Q19 and also has been exploring and developing a position in the Delaware subbasin of the Permian – cut its 2020 capital budget by 20% on Wednesday, trimming USD 500m from what had been announced earlier. The changes include suspending exploration activities and its operations in Oklahoma, which provided about a quarter of the 4Q19 production.
Those kinds of cuts, replicated en masse by shale drillers, could stifle acquisition interest in assets outside of the Permian Basin, the advisor noted. That is because public companies will not be willing to spend limited capital to test formations and optimize well designs needed to prove the viability and economics of a developing play.
“The second tier plays already had to fight like crazy for dollars from companies with broad asset bases in multiple plays and that probably won’t get better,” the advisor said. “There’s a lot of rock that is going to be sat on until something changes.”
The US government is reportedly considering some form of aid to oil and gas companies feeling the pressure of lower oil prices, according to a report Tuesday by the Washington Post. While it is not certain if aid is coming or what form it would take, the report suggested that low-interest loans are being considered.
by Nate Trela, Hana Askren, Heather West and Kasia Patel. With analytics by Philip Segal.
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