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Chevron-Noble announcement may not spark wave of near-term deals

While stagnant oil prices and shrinking capex may eventually force consolidation among US shale producers, analysts say Chevron’s recent announcement that it intends to buy Noble Energy probably won’t spark a near-term tidal wave of deals.

Instead, any transactions will likely be selective and stringently value-oriented. And while in the past production growth may have been a chief rationale for M&A, future deals are likely to take a sober, restrained view on output.

While oil patch watchers love to speculate on emerging trends based on a single event, some analysts before the July 20 Chevron-Noble announcement said they didn’t expect a merger cascade due to tight capital access from recent bankruptcies and debt refinancings.

Now they say there are reasons the Chevron transaction may have been a one-off, opportunistic event.

For one thing, the major paid a low premium – just 7% from the last trading day before news of the merger was unveiled to the public. So Chevron got a set of what Wall Street agreed were diverse, well-run and free cash flow-generating assets at a good price, Thomas Watters, managing director for S&P Global Ratings, said.

Certainly, the market has awaited greater consolidation for a while. With a couple of hundred operators in the Permian Basin, for example, most of them small, there is still room for transactions. And they still occur, although many remain bolt-on buys that add acreage rather than an entire company.

Also, whereas M&A was expected to step up production growth in years past, output hikes may not be as exuberant going forward, Watters said.

“Typically consolidation tends to lead to better production discipline … and less volatility in commodity prices,” he said. With fewer producers, only the best assets are produced, whereas production spread out over many operators “usually leads to less discipline because they’ll produce just to cover expenses and service debt.”

Chevron had “a little room” in its balance sheet to make the purchase, which was all stock – which Watters called a “conservative” approach.

“They didn’t really pay over market [and] had the wherewithal to do” the deal, he said.

That is important since Chevron had made a bid last year for Anadarko Petroleum, a with asset overlap in the Permian Basin of West Texas/New Mexico and the Gulf of Mexico — both arenas in which the major is a large, prominent player.

But days after Chevron’s $33 billion bid – a 35%-plus premium to Anadarko’s share price at the time — Occidental Petroleum made a come-from-behind $57 billion bid which Chevron ultimately decided not to top. Chevron also walked away with $1 billion in from Anadarko as consolation money for accepting a higher offer.

Chevron wasn’t looking for size, but value
That, and Chevron’s cash build since then through operational efficiencies and cost-slashing measures, meant it had money in its pockets to shop for a value-building acquisition. In fact, Chevron CEO Mike Wirth was asked repeatedly at conferences and calls over the past year if it were actively deal shopping, but he responded the company was not necessarily looking to get bigger but rather create value, and would only do a transaction that made sense.

Especially at the present time of fiscal austerity from low crude prices caused by sagging demand as the coronavirus pandemic ravages the globe, money is tight and companies are hard-pressed to cough up the cash for a large corporate deal that they’d have to finance.

And now, the cost of capital is ratcheting higher with a recent slew of Chapter 11 bankruptcy filings, some of which are high-profile such as Chesapeake Energy and Whiting Petroleum.The Chevron-Noble merger announcement’s timing came as a surprise to many analysts. “We suspected operators may wait for slightly higher crude prices before pursuing mergers,” investment bank Tudor Pickering Holt said in a July 21 investor note.

TPH said its “extensive conversations with investors” over the last two years have conclusively shown its clients favor “significant” industry consolidation.

Smaller number of operators may dominate in future
“Ultimately, we suspect investors would like to see all of upstream shrink to 10-15 independents, which may come naturally … or names may be pressured once crude prices stabilize toward $50/b as activism may slowly reenter the conversation,” it said.

There are other reasons to consider Chevron-Noble combo driven more by an opportunity – what Wells Fargo anlayst Nitin Kumar called Noble’s “unique cash flow generation” – than a bid for scale, since the major already has that and as well as size.

“As larger operators have cut capex and de-emphasized growth, the urgency for acquiring incremental inventory is less, in our view,” than might otherwise be the case if the sector was on a growth tear, Kumar said in a July 20 investor note.

S&P Global Platts Analytics does not expect significant M&A activity this year, but said deals resembling Chevron-Noble, involving “operators with strong balance sheets acquiring highly leveraged US operators,” could occur.

Right now E&Ps have reasonably attractive valuations and a continuing need to reduce costs. Integrated oils want to add short-cycle assets to their portfolios, Credit Suisse analyst Bill Featherston said in a July 20 investor note, suggesting some M&A is possible for select operators.

“We had expected the plunge in oil prices and uncertainty driven by [the pandemic] to cause a pause in M&A in 2020,” Featherston said. But “with E&Ps’ limited access to capital markets, acquisition opportunities are likely more open to majors than E&Ps.”

Featherston continues to expect consolidation to pick up post-2020, and sees Permian stalwarts Pioneer Natural Resources, Parsley Energy, Concho Resources and Cimarex Energy as the most likely takeover targets, based on what the analyst called their “large relative resource size and inexpensive valuations.”

Representatives of Pioneer, Parsley, Concho and Cimarex did not immediately return requests for comment.
Source: Platts

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