Volatility in commodity prices hasn’t stopped acquisitive-minded producers from paying top dollar to buy companies and build reserves in the past year. And even with the recent pullback in prices, energy analysts don’t expect to see a slowdown in mergers and acquisitions (M&A) anytime soon.

Petrie Parkman & Co. energy specialist George Morris told members of the Association of International Petroleum Negotiators in Houston last week that finding and development costs have nearly doubled in the past six years. But he said it is still less expensive to develop organic reserves than to purchase them. Petrie estimates the cost of buying reserves at around $3.68/Mcfe, while developing organic reserves costs about $1.99/Mcfe.

Nevertheless, this disparity in costs has not cooled the M&A market. Even with the recent commodity declines, oil and gas prices still remain at relatively high levels, and “there’s been a tremendous rally across the board in all sectors of the energy business.”

There have been a lot of mergers, big and small, just in the past year. Among those making headlines, ConocoPhillips completed its $35.6 billion merger with Burlington Resources Inc. (see NGI, April 3). Remington Oil & Gas was bought out by Helix Energy Solutions (formerly Cal Dive International) in a $1.4 billion deal (see NGI, Jan. 30). Petrohawk Energy Corp. more than doubled its reserves in a $1.59 billion merger with KCS Energy Inc. (see NGI, April 24). Anadarko Petroleum Corp. completed its $23 billion deal to buy Western Gas Resources Inc. and Kerr-McGee Corp. last month (see NGI, Aug. 28). And Calgary-based Canadian Natural Resources Ltd. said earlier this month it would pay $4.075 billion for Anadarko Canada Corp.’s assets (see NGI, Sept. 18).

Some analysts have questioned the high prices paid for many of the recent acquisitions, but Morris said producers don’t only look at the cost of buying reserves. They also see the decline in the average production-per-well in the United States, coupled with rising service costs. The high-priced deals might turn out to be a better long-term bet than many think.

“Buyers are looking at the forward curve,” Morris said.

Standard & Poor’s (S&P) analysts appear to agree. Credit analyst Ben Tsocanos said he expects the “bursts” of M&A activity to continue into 2007.

“Buyers have ratcheted up their commodity price expectations and recalculated the marginal cost of production upwards, or have stretched their estimates of a potential acquisition’s ‘2P’ (proved and probable) reserves and ‘3P’ (proved, probable, and possible) upward to arrive at recent acquisition valuations,” Tsocanos wrote. “It is clearly a seller’s market in the exploration and production (E&P) space, which is exacerbated by the high cost of finding and developing reserves.”

However, Tsocanos warned the recent acquisitions “will only make sense if strong market conditions persist. The prices are as much as 40% above the estimated cost to build comparable capacity, representing the premium that buyers are willing to pay for existing capacity in order to avoid construction risk and the chance that market conditions will deteriorate in the three to four years it would take to complete a sizable expansion.”

Tsocanos said recent announcements by ExxonMobil Corp., BP plc, ConocoPhillips and Anadarko to scrap plans to build liquefied natural gas (LNG) regasification plants in North America “could bode well for future merger activity among U.S.-based natural gas producers” (see NGI, Aug. 28). “LNG’s potential impact on longer-term U.S. natural gas pricing wanes each time plans for a new terminal are mothballed, at a time when competition for LNG cargoes is brisk throughout the world.”

The lack of LNG facilities, said Tsocanos, “may persuade producers that natural gas prices will remain above levels experienced in previous troughs, thus justifying high price multiples for proven reserves.”

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