Permian independents yet to show merger value

US independents that undertook two multi-billion dollar mergers in the Permian basin last year insist that their deals are paying off — but their share price performance suggests that investors are looking for more.

Concho Resources purchased smaller peer RSP Permian for $7.6bn in shares while taking on $1.7bn of debt in March 2018. This was followed by Diamondback Energy swooping up fellow Permian producer Energen in an all-stock $9.2bn transaction, including $830mn of net debt. The Energen purchase also came just days after Diamondback bought Ajax Resources for $1.25bn. Debt and equity investors saw the deals as ushering in a needed wave of consolidation in the US shale industry to cut costs and improve efficiencies in a volatile oil market.

Yet the stock market response to the successes the two say they have had in achieving their synergy and cost-reduction targets has been muted at best. Concho — producing 307,000 b/d of oil equivalent (boe/d) in the fourth quarter — is trading at around $111/share, compared with $158/share in March last year when the deal was announced. Diamondback — with fourth-quarter output of 182,600 boe/d — is trading at around $102/sharecompared with $138/share when its deals were announced in August 2018. The crude price slide in the fourth quarter of last year and continuing volatility may partly explain the share price drops, yet they overshoot the S&P 500 Energy Index's fall of just 2pc since March last year (see graph).

Concho's acquisition was expected to help save $2bn through operational synergies such as optimising development plans, sharing infrastructure and improving efficiency, the company said at the time. But it has since lowered its capital expenditure (capex) guidance for 2019 and 2020, cut its rig fleet for this year and pared its output growth expectations for 2019 and next year.

Concho says it has met its $60mn target of cuts to general and administrative costs. But the bulk of savings are due to come from drilling longer lateral wells and larger multi-well pads, which it is still working towards.

The company has not lost sight of its goals, chief executive Tim Leach says. "We are redoubling our focus on cost control, capital discipline and growing free cash flow and returns," Leach says. Concho's operating cost target for this year is $6-6.50/boe, against $6.14/boe in 2018. But it expects oil service costs to decline in the coming months as producers pare activity. And the firm will continue to shed non-core assets. US bank Tudor Pickering Holt expects Concho to deliver substantial free cash flow after 2020, when it has achieved its development and cost-saving goals.

Diamondback on track

Diamondback's capture of Energen similarly aimed to deliver it $2bn in cost savings. Key synergies included well drilling and completion cost reductions of $200/lateral ft across more than 2,000 locations in the Midland basin, and administrative savings of $30mn-40mn/yr. Diamondback is also looking at selling non-core assets. These plans are all on track, the firm says.

Diamondback's 2019 cost guidance of $785/lateral ft for the Midland basin is a saving of $215/lateral ft compared with Energen's second-quarter 2018 cost. That implies it has already achieved 95pc of the target laid out at the time of the deal.

"The benefit of size, scale and buying power on service costs has been greater than originally anticipated," chief operating officer Michael Hollis says. Diamondback expects additional savings of $150mn this yearin the Midland basin. The firm expects to lower well costs in the Delaware basin by about 7pc this year compared with 2018, saving $50-60/lateral ft. And it expects "even more capital, operating, midstream and mineral synergies,"Hollis says.