The recently announced mergers and acquisitions of smaller, growth-oriented independents by large exploration and production (E&P) companies bodes “very well” for U.S. drilling activity over the intermediate term, especially in the Rocky Mountains and the Permian Basin, according to the latest Raymond James’ Stat of the Week.

Analysts Wayne Andrews and Jeffrey Mobley focused on three specific acquisitions: Kerr-McGee Corp.’s agreement to purchase Westport Resources; Pioneer Natural Resources’ purchase of Evergreen Resources Inc.; and EnCana’s offer for Tom Brown Inc. Not mentioned, but also part of the E&P merger trend in North America is Petro-Canada’s announced purchase of Denver-based Prima Energy Corp. last week (see Daily GPI, June 10).

“Since long-term growth considerations are driving this boom, almost all of the companies and properties that are being bought share three key attributes: a long-lived reserve base, a multi-year inventory of drilling prospects and a moderate risk profile,” they said. Because of the expected growth, the analysts “look for the U.S. rig count to continue to post meaningful increases as the large independents begin accelerating drilling programs on their newly acquired assets.”

The large E&Ps are buying smaller independents for the growth opportunities, said the analysts. “With natural gas well above $6/Mcf and crude oil around $40/bbl, large-cap E&P independents are making excellent financial returns. In particular, they are experiencing tremendous free cash flow above and beyond their budgeted capital spending plans.”

The major challenge is the “dearth of drilling prospects, particularly in areas with long-term growth potential. As a result, acquiring mid- and small-cap peers, or assets from other majors, is becoming an increasingly popular means for large-caps to enhance their growth outlook for the next five to 10 years.”

The Rockies, with its coalbed methane potential, and the Permian Basin, with revitalized gas production, offer a “massive inventory” of drilling prospects that growth-hungry E&Ps can turn into a highly profitable production stream.”

Mobley and Andrews said that their “long-standing thesis — that the equity markets are largely under-pricing E&P companies — remains firmly intact.” Because of the under-pricing, they believe “there is a good probability of further consolidation in this sector…From the standpoint of the oil service sector, this trend represents a clear opportunity to capitalize on a meaningful increase in domestic drilling activity. In short, it is the best of both worlds for E&P and oil service sectors.”

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