Consolidation between oil and gas independents is expected to accelerate as the turn toward an energy transition turns on climate change initiatives, according to research by Wood Mackenzie.
“A world on a 2 C glidepath does not need thousands of Independents chasing volume,” said consultancy Vice President Luke Parker.
Oil and gas investors are gravitating toward stable dividends, which are underpinned by, among other things, solid balance sheets and low capital costs, along with top environmental, social and governance, or ESG, ratings. Putting those together, upstream exploration and production companies (E&P) could face existential choices.
“The independents’ strategies will need to evolve, as they move to minimize risks they can control,” Parker said. “For most, investment horizons will get progressively shorter across the board — exploration, development and acquisition. Anything that does not pay back in a narrowing timeframe will be increasingly overlooked.
“But with that shift, the very nature of the independents will change. The risk-reward balance that has always been core to the E&P ‘value proposition’ gets diluted. Independents increasingly look and act like larger companies, only without the advantages of actually being a larger company.”
The “defining theme” for the coming decades is likely to be consolidation. Many of the “most attractive” E&Ps could combine as “pure-plays with niche attributes at scale or diversified ‘mini-majors’ with growing carbon, capture, utilization and storage, or renewables businesses.”
The E&Ps best positioned for the future would be able to evolve with the times. While they could remain independent the longest, those E&Ps also would “make the most attractive consolidation targets,” Parker said.
Wood Mackenzie said the “consolidation pathways” could go three ways. There could be new “big energy players,” as operators shrink their upstream operator or exit oil and gas completely. For the “new big oil players,” the consultancy expects vertical mergers and value chain integration to be a common feature for late-cycle consolidation.
In addition, some big oil operators could get even bigger. For example, Chevron Corp.’s takeover of Noble Energy inc. “could be a sign of things to come.”
Other recent tie-ups of late include ConocoPhillips’ stock-for-stock merger with Permian Basin pure-play Concho Resources Inc. In addition, Devon Energy Inc. is taking over WPX Energy Inc., while Pioneer Natural Resources Co. is trading stock to buy rival Parsley Energy Inc. Houston-based Contango Oil & Gas Co. also agreed to an all-stock merger with Mid-Con Energy Partners LP. And Calgary’s Cenovus Energy Inc. agreed to swap shares to buy rival Husky Energy Inc.
“We may come to look back on the last few months as the beginning of the consolidation that will define the oil and gas sector over the coming decade and beyond,” Parker said.
Wood Mackenzie also expects privatization to become part of the future. Private equity, hedge funds and sovereign wealth funds should be opportunities to buy “low-multiple and high cash flow companies” that may struggle to attract additional funding.
“Essentially we are talking about companies that will find it increasingly difficult to operate in public hands,” Parker said. “Taking them private – free from stakeholder pressure, with an advantaged cost of capital and different investment horizon – could be a lifeline to many. But while this will be a theme in the evolving corporate landscape, it will not be dominant. We do not expect to see the entire E&P space taken private. Cost will be an issue for one.”
The overall dynamic is shifting, he said. “The Independents will no longer get endless chances to re-invent themselves. Failure at the margin will, increasingly, be terminal.”
[On March 1, 2021, NGI added three new points to its Forward Look data service, including an Agua Dulce point. Interested in adding affordable, robust natural gas forward curves to your business resources? Start a trial here.]
Flat E&P Spending
In related news, Rystad Energy said in a recent report the global E&Ps are forecast to invest $380 billion next year, flat from 2020. However, about 20% of the estimated spend “could be at risk of deferral or reduction, with the remaining amount being categorized in the safer tiers of low and medium-range risk.”
With the “uncertain roll-out timing of the recently announced Covid-19 vaccines, it’s worth expanding the forecast to a range of $350 billion to $430 billion, incorporating some scenario deviation,” analysts said.
E&P Investments could rebound to the pre-Covid level of $530 billion by 2023 if oil prices rise to around $65/bbl. However, analysts noted that after the market crisis in 2014 with oil prices plummeted, “annual E&P investments never recovered to the pre-crisis level of about $880 billion,” instead settling at $500-550 billion.”
Some of the spending reduction came from efficiencies, but there’s little room to do that this time. E&Ps now are pulling other levers, said Rystad, by deferring infill drilling programs, delaying sanctioning and start-ups, writing off stranded assets and reshaping portfolios.
“As E&Ps are also speeding up a transition into low-carbon energy, it is possible that this time, too, upstream investments will not return to pre-crisis levels in the long-term, even if they do recover somewhat over the next few years,“ said Rystad’s Olga Savenkova, upstream analyst.
© 2021 Natural Gas Intelligence. All rights reserved.
ISSN © 2577-9877 | ISSN © 1532-1266 | ISSN © 2158-8023 |