Despite an absence of $5 billion-plus mergers and acquisitions (M&A) in the oil and gas patch, overall deal activity is rebounding on the strength of mid-size deal flow driven largely by onshore resource plays and offshore Gulf of Mexico (GOM) economics, according to analysts at Raymond James & Associates Inc.

ConocoPhillips’ $35.6 billion acquisition of Burlington Resources in December 2005 (see Daily GPI, Dec. 14, 2005) — now a distant memory — dwarfs a more recent asset sale by Dominion to ENI in April 2007 (see Daily GPI, May 1, 2007), valued at $4.8 billion, but more modestly sized deals are routinely in the offing, the analysts found. For instance, XTO Energy Inc.’s $4.2 billion acquisition of Hunt Petroleum (see Daily GPI, June 11), announced this month, is focused on resource plays in East Texas and central/northern Louisiana. “The deal’s elevated multiple ($3.98 per proved Mcfe) illustrates the premium valuations being assigned to resource play assets,” Raymond James analysts said in a Monday research note.

Following a year-long slowdown, recent acquisitions by Cabot Oil & Gas (see Daily GPI, June 6) and Berry Petroleum (see Daily GPI, June 12) in the $600 million area also targeted East Texas, but this isn’t the only region to garner the attention of dealmakers. The Rocky Mountain region, including its oil-rich Bakken play, have attracted XTO, Whiting Petroleum and Williams Companies, the analysts noted.

In the GOM, Stone Energy’s $1.8 billion ($4.37/Mcfe) purchase of Bois d’Arc Energy (see Daily GPI, May 1) “represents the latest in the offshore consolidation trend dating back to Norsk Hydro’s purchase of Spinnaker Exploration in 2005 [see Daily GPI, Sept. 20, 2005],” the analysts said. The GOM offers relatively short reserve lives compared to the resource plays. However, GOM operations provide rapid payout rates and free cash flow generation, hence their attractiveness to acquirers.

It’s no secret that with natural gas averaging more than $10/Mcf and oil well over $100/bbl for the year, large and mid-cap exploration and production (E&P) independents are doing quite well, thank you. For some, free cash flow exceeds budgeted spending plans. “While debt repayment and stock buyback are sensible options, most E&P balance sheets are in good shape and these companies’ core competency is reinvesting in future growth through the drillbit,” the analysts said. “As a result, acquiring their smaller peers, or assets from the majors, remains a very popular means for operators to enhance their growth outlook for the next five to 10 years.”

Raymond James notes that interest in resource plays has been boosted by the recent boom in shale gas discoveries and advances in well productivity that make the plays economically viable. “The rationale for Gulf of Mexico deals is typically different…[F]or many acquirers the rapid rate of cash flow generation more than compensates for the lower growth outlook.”

Despite the attractiveness of domestic assets, the majors are staying away. Among them is ConocoPhillips, whose CEO earlier this year noted that M&A was not in its plans for this year or next (see Daily GPI, Jan. 24).

But why are “mega-cap” corporate M&A deals still in hiatus? Raymond James notes a number of factors, including:

So for at least the near term the North American M&A market will be the playground for mid-cap and super independents. “The Rockies, East Texas, Barnett Shale and Appalachia, as some of North America’s premier areas for oil and gas resource accumulation, should continue to be important components of the ongoing acquisition trend,” the analysts said. “In addition, given the tremendous cash flow generation of offshore properties, the Gulf of Mexico is likely to remain a focal point.”

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