Energy Dealmaking in Texas Is Scarce Despite U.S. M&A Boom
(Bloomberg) -- Concho Resources Inc.’s $9.5 billion purchase of rival RSP Permian Inc. in March was supposed to herald a merger boom in the oil-rich parts of Texas and New Mexico. Instead, the deal stands out amid a fallow period for dealmaking in the region.
The Permian Basin, the largest and most productive oilfield in the U.S., should be ripe for consolidation, according to industry experts. Oil prices have stabilized at more than $60 a barrel, putting many producers there comfortably back into profitability after the crash of 2014.
The basin is dense with potential dance partners, including more than a dozen publicly traded companies that exclusively drill in an area roughly the size of South Dakota. Pairing up makes economic sense, particularly among neighbors, where coming together could enable them to drill longer, more profitable wells.
Yet companies in the region face hurdles to securing investor backing for deals.
"The oil and gas world has not had a lot of corporate M&A, certainly relative to other sectors," Jay Horine, global head of energy investment banking at JPMorgan Chase & Co., said in an interview.
Explorers are mostly focusing internally on matters such as board compensation, capital structures, asset sales and costs, he said. Dealmaking isn’t the priority.
The M&A data reflects that. There have been $35 billion in exploration and production deals announced in North America so far this year, according to data compiled by Bloomberg. That’s down about 47 percent from same the period in 2017, when companies completed $65.15 billion in deals.
Deals involving U.S. companies in all sectors topped $1.3 trillion in the first half of 2018, the busiest start to a year since at least 2006.
The Permian is the center of the U.S. oil boom for a few reasons.
It’s huge, at 250 miles wide and 300 miles long. It is also has unique geographical features. Unlike most basins, it has a lot of areas where several layers of oil-soaked rock are stacked, like layers in a cake.
While wildcatters have been drilling in the Permian for about a century, they only figured out how to make money from shale in the last two decades thanks to hydraulic fracturing.
While the Permian has large extracts of land still untapped, explorers have become cautious about buying entire companies to get at it, according to Lackland Bloom, a senior managing director at Guggenheim Partners.
"Investors have laid down a new set of rules for the industry," Bloom said in an interview. "The upshot is that there is a clear desire to see companies invest more prudently, go at a slower pace, focus on returns and at the same time generate free cash flow."
Wall Street didn’t love Concho’s deal for RSP; its shares fell more than 10 percent the day it was announced. While Concho executives said the deal made strategic and financial sense, investors fretted over the 29 percent premium over RSP’s share price it had agreed to pay.
DiamondBack Energy Inc., another Permian-focused explorer, had bid for RSP but abandoned its pursuit over pricing concerns, according to people familiar with the matter, who asked to not be identified because the matter isn’t public.
Representatives for Concho and Diamondback didn’t respond to requests for comment.
Some analysts have since downplayed the concerns about the deal. That includes Brian Singer at Goldman Sachs Group Inc., who described them as overdone.
That view is echoed across the industry as companies including Kinder Morgan Inc. and Targa Resources Corp. build new pipelines in the Permian. This is important for easing bottlenecks that have built up in getting the basin’s oil and gas to market.
Right now there isn’t enough infrastructure for handling the production boom. This logistical problem has made investors bearish on Permian stocks this year, which has also made dealmaking more difficult, as volatility makes buyers and sellers skittish.
This will change, experts say.
"Permian bottlenecks do exist and are impacting wellhead pricing and drilling economics in the short term, but in our view this will get worked out over the next 18 months through large capital projects," Jason DeLorenzo, managing partner at energy-focused private equity firm EnCap Investments LP, said in an emailed statement in response to questions.
"Over the longer term, we continue to view the Permian as great resource and think M&A activity will pick back up over time," DeLorenzo said.
He’s not alone.
The "industrial logic" of partnering up to get bigger and more efficient should eventually spur consolidation in the Permian, particularly among smaller companies, according to Ralph Eads, chairman of energy investment banking at Jefferies Group LLC.
"There’s about 30 of these companies and there doesn’t need to be that many,” Eads said in an interview.
Another positive sign for Permian dealmaking: at least one large explorer may be getting ready to make a big bet there. BP Plc has emerged as the front-runner for BHP Billiton Ltd.’s onshore operations in the U.S., which includes a sizable position in the basin, people familiar with the matter said earlier this month.
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