MIDLAND, Texas — So far in 2023, M&A has been dominated by blockbuster deals as the oil and gas market has seemingly hit the perfect spot for both sides of the table.
Going forward, the driving force for companies in a re-established oil and gas industry will be creating a position for the future, said Tim Perry, vice chairman of Global Energy Group at RBC Capital Markets.
“We've gotten in this situation where (crude prices per barrel are) $80, $75, $65, $70 long-term strip,” Perry said on Nov. 15 at Hart Energy’s Executive Oil Conference and Exhibition. “It's an area where both buyers and sellers feel very comfortable transacting. It's almost like Goldilocks—it's not too low, it's not too high.”
In the second quarter, M&A deals tripled in value to $24 billion from the prior quarter, according to an August analysis by Enverus.
Civitas made two deals worth $4.7 billion as in advanced its position in the Midland and Delaware basins. The trend continued into the next quarter, headlined by Exxon Mobil’s $60 billion acquisition of Pioneer Natural Resources’ assets in the Midland Basin—followed quickly by Chevron’s agreement to merge with Hess in a $53 billion deal.
The surge in the marketplace followed trends that were building for more than a decade, but that began to come to a head following the COVID-19 pandemic in 2020, said Greg Chitty, managing director of Jefferies, who also spoke at the conference.
“One interesting thing to talk about today is we've seen a massive transition from I would say the period in 2020, [in] which everyone thought oil was going away,” Chitty said.
The oil and gas market has been bottled up for more than a decade, as trends globally pushed investments toward alternative energy sources. Some investment firms also divested from oil and gas holdings. Russia’s invasion of Ukraine and the difficulty faced by some alternative energy companies came to a head beginning last year.
“We are very bullish on supply and demand simply because now we're entering year 15 in underinvestment” in oil and gas, Chitty said. “I mean that is a staggering thought when you think about it.”
While the industry sees more companies willing to finance, the investor base has changed, Perry said. The sector is still short of dollars flowing in while E&Ps remain undervalued in the S&P 500. Energy stocks only account for less than 5% of the market-valued weighted S&P 500.
“A lot of the market is made up of generalists, and a lot of generalists really don't understand this industry,” he said. “And as a result, it's been harder and harder for this industry unfortunately to really get investor dollars to come into it.”
In the past, Wall Street firms would pick a company and “park” investments in a company for 10 years, Perry said. Today, investment firms have more of a renter’s attitude towards their investments – they want to be able to get in and out of their holdings, focusing instead on trading liquidity.
Large-cap advantage
Investors mindset works to the advantage of large-cap companies, Perry said.
“What's really happened over the last three years is we've shifted from an industry that was focused on growth and adding rigs [into] an industry that's a much slower growth, growing flat to 5%, but really focused on return in capital and free cash flow,” he said/
Larger companies are incentivized to continue buying assets to keep pace with production— particularly as their equity values eclipse their smaller peers on Wall Street.
“If you are a very large company, you want Tier 1 inventory. You also want to be able to show, a near-term accretion,” Perry said. “Well, when you trade a turn to turn and a half higher, 20 to 25% higher on your multiples, it's much, much easier for a large cap company to buy a medium or smaller company.”
And large companies are primarily focusing on the leading growth sector of the U.S. gas and oil market—the Permian Basin—for their supply.
“The Permian has the most inventory and frankly, it's the easiest way to generate a near-term barrel,” Chitty said. “So that makes it nice. When you get in situations where you're going to have just-in-time problems, you need a valve to quickly solve that problem.”
Chitty said other basins in the U.S. lack the advantages of the Permian. While the Haynesville Shale has shown growth, it’s a gassy play that, to some extent, has its fate tied to future LNG projects. Similarly, the Appalachian Basin faces its own headaches, including political opposition and an inability to permit new pipelines, even to neighboring states.
“We see that continuing because we don't see any of their basins providing growth,” Chitty said. “And it's difficult unless there's a real strategic push in a particular basin and a particular asset, versus the Permian, where it’s an easy button that’s widely accepted by Wall Street, especially for the public.”
Both analysts pointed out that while the investment market has changed, larger companies have started to go after future deals with the more traditional purpose of setting their company up for the long-term, rather than responding to immediate market needs.
“When you look at Chevron and Hess, that was more a classic deal, where they saw some value out past what the public would say is a slam dunk,” Chitty said.