Mergers and acquisitions (M&A) within the U.S. upstream fell to their lowest annual volume in nearly two decades last year, according to new research by Enverus Intelligence Research (EIR).

Exploration and production (E&P) firms recorded 160 transactions valued at $58 billion total, the Enverus subsidiary found. This is the lowest number of deals since 2005.

The combined deal value was down 13% year/year, and about 20% below pre-pandemic averages. Twenty-six of the transactions, with a combined value of $13 billion, occurred in the fourth quarter.

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Recent dealmaking has been driven by large, publicly traded operators targeting top-tier assets in billion-dollar-plus transactions, said EIR researchers.

Heavyweights such as Devon Energy Corp., Diamondback Energy Inc. and Marathon Oil Corp. “dominated deal activity in the back half of 2022,” said EIR’s Andrew Dittmar, director. “These buyers have the balance sheet strength and favorable stock valuations to take advantage of large, high-quality offerings from private sellers. Critically, they can strike deals that [are] both accretive to current cash flow and extend their runway of drilling locations.”

He added, “For smaller companies, which are still having their equity value discounted, it is challenging to thread the needle of buying assets at accretive multiples and being able to pay for inventory.”

Last year’s low deal count notwithstanding, the EIR team is expecting an active M&A market for upstream firms in 2023.

This is because of the need of publicly traded E&P firms to secure inventory, Dittmar said.

“The challenge for deals, as is often the case in this industry, will be bridging the bid-ask spread and navigating commodity price volatility,” he explained. “Oil prices are likely to be steady or rising during the first half of the year while gas struggles, meaning more oil deals and fewer for gas to start 2023.

“However, we could see interest in buying gas assets mid-year to take advantage of low prices ahead of a U.S. LNG export ramp that will eventually drive gas higher.” 

Over the nearer term, limited incremental liquefied natural gas export capacity is expected to keep U.S. gas demand and prices in check.

The Biggest M&A Deals In 4Q

Continental Resources Inc.’s billionaire executive chairman Harold Hamm recorded the fourth quarter’s largest deal when his family purchased the firm’s outstanding common shares for $5.22 billion and took the formerly public company private. “However, that was a unique situation because they already owned most of the company,” the EIR team said.

Marathon Oil captured the quarter’s second-largest deal with its $3 billion cash purchase of Ensign Natural Resources. The natural gas and condensate-rich assets of privately held Ensign nearly doubled Marathon’s position in the Eagle Ford Shale.

Diamondback snagged the third and fourth spots with a pair of acquisitions in the Permian Basin’s Midland formation. The firm added more than a decade’s worth of inventory when it purchased privately held Firebird Energy LLC in a $1.59 billion cash-and-stock transaction.

The following month, Diamondback announced a $1.55 billion cash-and-stock agreement to acquire the West Texas assets of Lario Permian LLC. Cumulatively, Diamondback spent a little more than $3 billion to add nearly 500 new drilling locations that are “highly economic in the current oil price environment,” EIR said. 

“For Diamondback, adding inventory is more of a luxury than a necessity as the company already has more than a decade’s worth of top-tier inventory.”

Researchers added that Marathon is also well positioned with about 10 years’ worth of drilling locations that are economic down to $45/bbl. The company added another 550 locations to its portfolio with the Ensign acquisition, which was the largest Eagle Ford deal since Chesapeake Energy Corp. purchased WildHorse Resource Development Corp. for $4 billion in 2018, the EIR team noted. 

“E&Ps of all sizes have proven to investors they can be profitable and pay dividends,” Dittmar said. “Now the key question is how long they can sustain profitable margins, determined by commodity prices which they can’t control and the quality of their drilling opportunities which they can control, at least to an extent.”

What About The Small Caps?

Dittmar explained that larger public operators have an advantage over their smaller peers in terms of inventory, “and investors recognize that by giving them a premium on their stock. In turn, they can use that premium to buy more assets. It is a market where the rich get richer.”

Most M&A assets on the market in recent years have come from private equity sellers, a trend that is likely to continue, the EIR team said. “Public companies’ concurrent appetite for inventory is giving them an ideal window to sell. That said, there are few fire-sale bargains to be had, and sellers are willing to walk away from a deal if none of the offers meet their minimum price.”

Pickings are slim for smaller names “struggling to secure inventory in the current market,” Dittmar added. “Corporate M&A hasn’t been a significant part of the market since 2020, but we could see a return to public company deals this year either from small companies combining in mergers of equals to build scale and hopefully get a higher multiple on their stock or selling to larger competitors that already trade at a premium valuation.” 

EIR analysts expect smaller operators to “stay independent and focus on adding less expensive inventory in areas like the Permian Rim or Powder River Basin. They could also try to capitalize on non-core assets shed by large cap companies.”

Researchers cited that already this year, Chesapeake sold its Brazos Valley asset “at what looked to be a buyer-friendly price” to privately held WildFire Energy LLC, rather than to a large public buyer.

“If large, strategic M&A is too expensive, smaller companies could also look to build inventory block-by-block in a return to a higher volume but lower deal value M&A market,” researchers said. As an example of this strategy, they cited Permian Resources Corp.’s $98 million acquisition this month of 4,000 net leasehold acres, 3,300 net royalty acres and 1,100 boe/d (73% oil) of net production, located mostly in Lea County, NM, from an undisclosed third-party.

The fourth quarter also saw ExxonMobil offload a package of assets offshore California to special purpose company Sable Offshore Corp. in a deal valued at $625 million.