Calling the recent pace of oil and gas producer merger activity “breathtaking,” Standard & Poor’s Ratings Services (S&P) weighed in with the reasons for the robust deal activity.
“Several factors are at play, but the one most commonly cited is the yawning chasm between robust oil and natural gas prices on the futures markets and the rather tepid prices implied in producers’ equity valuations,” S&P credit analyst John Thieroff wrote in a Wednesday research note.
Companies in a buying mood have grown comfortable with paying $20/boe and more in merger and acquisition (M&A) deals because they’re able to hedge oil production at $70/bbl and gas at an average of $8-9/MMcf. [Anadarko Petroleum CEO Jim Hackett elaborated on this point when he explained his company’s plans to buy Kerr-McGee Corp. and Western Gas Resources Inc. (see Daily GPI, June 26).] Hedging a couple of years’ worth of production at these price levels allows acquiring companies to quickly repay acquisition debt.
Debt is a popular means for financing deals these days as acquirers have been enjoying years of strong cash flow due to high commodity prices. They also are loathe to issue equity because they believe the market is undervaluing their shares relative to commodity prices.
The second quarter alone has seen a spate of deals:
“Another interesting dynamic currently at play is the pronounced disconnect between spot oil and natural gas prices,” writes Thieroff. “Although inventories for both remain relatively strong (especially for natural gas), spot oil prices have stubbornly remained above $70 a barrel in recent weeks, while spot natural gas prices have sagged toward $6 per Mcf from the low teens early in the year, creating a gap much wider than the implied energy equivalent ratio of 6:1.”
Thieroff blames the breakout from the 6:1 price ratio on concerns about security of supply in Iran and Nigeria, creeping nationalization in Latin America and western access to Russian reserves. “All of these, along with ongoing uncertainty about Iraqi development, have conspired to provide a significant, if unquantifiable, premium in oil pricing.”
On the other hand, natural gas supplies look strong with a North American drilling boom showing no signs of abating. “[I]f demand doesn’t pick up strongly (i.e., if there isn’t a hot summer or early, cold winter) it could be a tough winter for companies focusing heavily on gas production,” Thieroff writes.
Companies that aren’t plowing cash into acquisitions or expanded drilling programs are actively pursuing share repurchases. “Although stock buybacks during periods of abundant cash flow are to be expected, there’s a growing sense among investors on Wall Street that companies need to pursue larger, higher-impact share repurchases to create a better equity story rather than conduct steady, ongoing buyback programs funded with cash flow as available,” Thieroff said in his note.
Some larger share buybacks, such as those by Noble Energy Inc. (see Daily GPI, May 17) have been funded by asset sale proceeds. Nabors Industries, Cameron International Corp., BJ Services Co., and Global Santa Fe Corp. have funded recent share repurchases with debt, S&P noted.
“Underperforming companies and those viewed as lacking attractive reinvestment opportunities while sitting on large piles of cash remain under pressure to undertake large, leveraged share repurchases to appease shareholders,” wrote Thieroff. One such instance is the push by hedge fund and activist shareholder Jana Partners LLC to force Kerr-McGee into a $4.5 billion share buyback last year (see Daily GPI, April 28, 2005). Jana has recently been pressuring The Houston Exploration Co. to pursue a similar strategy (see Daily GPI, June 27).
©Copyright 2006Intelligence Press Inc. All rights reserved. The preceding news reportmay not be republished or redistributed, in whole or in part, in anyform, without prior written consent of Intelligence Press, Inc.
© 2020 Natural Gas Intelligence. All rights reserved.
ISSN © 1532-1231 | ISSN © 2577-9877 |