US oil company Occidental Petroleum's agreed $12bn takeover of producer CrownRock has sent valuations in the Permian basin surging to pre-pandemic levels, suggesting the top US shale formation is about to get even more expensive.
Valued at more than $50,000/acre after accounting for existing production, according to Enverus Intelligence Research, the hefty price tag for CrownRock reflects fierce competition to secure what is left of the Permian's highly sought-after inventory. It also bodes well for some of the other large Permian firms seen as takeover candidates, including Endeavor Energy Resources and Mewbourne Oil.
The underlying logic behind the recent mergers and acquisitions (M&A) wave — led by ExxonMobil's $59.5bn acquisition of Pioneer Natural Resources and Chevron's $53bn move on Hess — is a pressing need by some of the bigger producers to extend their stock of future drilling locations. Only about six years of the highest-quality inventory is left in the shale patch at current drilling rates, according to Enverus, and more than 70pc of that lies in the Permian. That signals the bidding frenzy is far from over. Scaling up now also provides a pathway for future discoveries as producers can test additional drilling zones within the Permian, while future productivity breakthroughs could also help them squeeze more out of the oil-soaked rock.
The $9.1bn of new debt Occidental is taking on to pay for CrownRock drew some unfortunate comparisons with the ill-timed $55bn acquisition of Anadarko Petroleum on the eve of the pandemic. It took a rebound in oil prices coming out of the downturn to restore the company's fortunes, as well as a vote of confidence by billionaire investor Warren Buffett, who has been steadily increasing his stake in Occidental. In any case, chief executive Vicki Hollub plans to cut the additional debt in half within a year on increased cash flow and $4.5bn-6bn in asset sales.
As well as an estimated 170,000 b/d of oil equivalent of additional output, Occidental also gets around 1,700 undeveloped locations in the Midland sub-basin of the Permian. Flush with cash from last year's run-up in oil prices, acquisitions are also a preferable way to grow in the minds of many investors who remain wary of any efforts to boost output given past excesses.
Lateral thinking
"With rates going up and their cost of capital going up, they're probably not looking as much at wanting to drill 50 new plots but rather, can we buy someone else and grow out," Hennessy Funds chief investment officer Ryan Kelley says. The current fad for drilling ever-deeper lateral wells also plays into this theme as producers can become more efficient by acquiring contiguous land.
One potential sticking point is the greater scrutiny being paid to M&A by the Federal Trade Commission under President Joe Biden's administration. The regulator has already requested extra information about the proposed transactions by ExxonMobil and Chevron, with Senate Democrats calling for them to be investigated on competition grounds. Chevron said the closing of the Hess deal could be delayed beyond the first quarter of 2024 as a result.
Still, next year is unlikely to see any let-up in terms of deal activity, with 67pc of respondents in a survey by investment management firm Evercore ISI expecting to see more industry consolidation compared with 2023. Even after this year's mega-deals, there are still far too many operators in the shale patch, financial services firm Pickering Energy Partners director Robert Mills says. Public companies are still not receiving much recognition from investors and getting bigger via deal-making is one way to do that. "The narrative has been ‘more please' and it will continue to be ‘more please'," Mills says of the outlook for deals.
