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Wells Fargo: Cheap Gas, Deep Pockets Drive U.S. M&A

Majors and national oil companies (NOC) are about to go shopping again, and their most likely targets are companies such as Anadarko Petroleum Corp., EOG Resources Inc., Whiting Petroleum Corp., Kodiak Oil & Gas Corp. and Forest Oil Corp., Wells Fargo Securities analysts said in a note last week.

The majors and NOCs have huge cash reserves, access to cheap capital, looming tax-related disincentives to disburse more dividends, and high stock prices, analyst David Tameron and his associates said. On the sell side, personal/family issues such as retirement and health of principals "have been and will continue to remain the dominant reason for sellers and thus corporate M&A [mergers and acquisitions] activity," the analysts said.

"In addition, an uncertain regulatory environment, a growing distaste of the public markets (including private opportunities), lack-of-scale issues, and technical talent issues are also motivating sellers."

And then there is low natural gas prices. "E&Ps with large exploration/development potential or leasehold issues alongside constrained liquidity may look attractive as takeout candidates," the analysts said. "The flip side of this is that from a liquids perspective, with crude ranging between $80-100/bbl, many management teams may also want to sell into a robust crude strip."

Likely acquirers in the next spate of M&A activity, according to Wells Fargo, include China's CNOOC Ltd., Korea National Oil Corp., Chevron Corp., ConocoPhillips, BG Group, PetroChina, Petronas, Royal Dutch Shell plc, Sasol, Sinopec, Statoil and ExxonMobil Corp. In addition, BP plc, Kuwait Petroleum Corp., Ecopetrol and Eni are possible but less-likely acquirers.

Besides Anadarko, EOG, Whiting, Kodiak and Forest, other likely targets, according to the analysts, include Approach Resources Inc., Chesapeake Energy Corp., Concho Resources Inc., Oasis Petroleum Inc., PDC Energy Inc., Rex Energy Corp., Range Resources Corp. and Lone Pine Resources Inc.

Acquisition of U.S. assets by Chinese companies would not be an easy sell no matter who is president, but Wells Fargo said a Romney administration might be more friendly to the idea given his capital markets experience and constituency. The general size and asset concentration of a particular target would at least partially dictate the level of national security concern a proposed deal would raise, the analysts said.

"We are obviously biased in our preference for North American E&P assets, but...we understand why the majors/NOCs have been returning to North America and establishing major footprints in unconventional resource plays in North America," Wells Fargo said. "M&A activity has been solid, although to date the majority has been private companies and/or targeted asset packages. But as these packages and assets continue to disappear and as the majors/integrateds and national oil companies look for larger footprints, we think the environment supports continued corporate M&A."

Potential acquirers are sitting on plenty of cash, Wells Fargo noted, as economic uncertainty has dictated prudent spending. "The aggregate cash level of the top 18 energy companies with public data sits at over $200 billion," the firm said. "We understand the logic behind taking a conservative route but believe shareholders will eventually demand a return of cash if no explicit use has been outlined. One example is Chevron, which has made a lot of noise as of late for having over $20 billion of cash on its balance sheet."

Depending on what happens with the Obama administration tax plan, investors might say "no thanks" to receiving more of that extra cash in the form of increased dividends. The tax rate for those with incomes over $250,000 could jump to 42.5% from 15%, lowering the effective dividend by about 33%, Wells Fargo noted. This would wipe out five years of dividend growth for companies like ExxonMobil or Chevron.

Share buybacks aren't likely either as stock prices are relatively elevated. Deleveraging has been accomplished already to a large extent. All this combined makes acquisitions more attractive.

"It is not hard for us to understand why, after decades of chasing higher-risk opportunities in remote/insecure corners of the world, large energy producers would return to the relative security of energy production in North America," Wells Fargo said.

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