Today, Chevron (NYSE: CVX) announced they plan to acquire Anadarko Petroleum (NYSE: APC). We saw many corporate deals struck last year (Concho/RSP Permian, Diamondback/Energen, Encana/Newfield, etc.) and have expected sector consolidation to continue in 2019 as oil prices have rebounded and companies look to benefit from strategic synergies. This has been a key investment theme for the independent exploration and production (“E&P”) companies (or, “producers”) and we view this as a positive catalyst for the group. Specifically, we would highlight the following takeaways from recent acquisition announcements:
- The majors have been planning to grow onshore US oil production over the coming decade (particularly in the Permian Basin). Consolidation allows these larger companies to achieve their production goals more quickly than anticipated.
- As producers focus on generating strong corporate returns, they have been depleting their core drilling inventory in some cases. Acquiring high quality locations can extend core drilling inventory life significantly and alleviate future production concerns.
- Consolidation, particularly by the majors, of US onshore production further validates the attractiveness of short cycle production (3-6 months from drilling to full production) which has the potential to fill a global supply shortfall of crude oil production from underinvestment in long lead time projects (3+ years).
- Corporate deals may be struck at accretive valuations as larger, well capitalized, lower cost of capital acquirors can pay a premium and still add significant value to shareholders going forward.
- In most cases, the implied value of these companies at announced deal terms are well above market price and supports a valuation floor for the producers. It also highlights the substantial value embedded in these producers, especially to a strategic buyer.
- As we have discussed in a prior piece, we believe the land grab phase is largely over and the lowest cost, short cycle barrel of production that can be developed quickly, efficiently and in a disciplined manner will prevail long term. This “manufacturing” or “development” mode requires economies of scale. Large companies, such as Chevron, have the scale to benefit from a larger footprint.
- Synergies are achieved in several ways, again supporting value to a strategic buyer: lower cost of capital, G&A cutbacks, economies of scale, more contiguous acreage providing more efficient development, and the potential to provide low cost feedstock to downstream segments.
Given the benefits of consolidation, we could envision a scenario in the next decade where only a handful of producers control the majority of production, especially in the Permian Basin. We believe announcements to date, are only the tip of the iceberg. Again, we view further consolidation as a continued positive catalyst for these producers as costs are cut and synergies gained leading to a potential long-term increase in free cash flow generation. In the new shale era of short cycle, disciplined and efficient production, we believe that we will continue to see rational consolidation in the sector.
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