Consolidation in the U.S. energy industry has been occurring across a variety of sectors, from oil and gas, to services, to power and renewables. Very different dynamics are at play in each sector, but across the board there is a trend toward mergers around specialized capabilities and technologies, as well as shoring up holdings by existing operators to improve efficiency. M&A activity in the oil and gas sector comes on the heels of almost three years of depressed oil prices and major cost reductions in upstream operations. Global oil and gas companies cut expenditures by almost 40 percent between 2014 and 2016, hundreds of thousands of people were laid off, and major projects were either shelved or cancelled altogether. The American shale revolution in light tight oil (LTO) and shale gas created an entirely new business environment and market dynamic with shorter lead times and well life-cycles, developments that meant the tap could be turned on and off more quickly. This fundamental change engaged a plethora of smaller operators who ran small numbers of wells situated in a patchwork of drilling sites. In the past few years as low prices pushed many of these tiny producers out of the market, the sector has seen significant consolidation not under traditional majors, but under a few dominant companies like Chesapeake Energy, EOG Resources, and Whiting Petroleum. Indeed, the story is the same in much of the energy sector, where consolidation is taking place within specialty sectors rather than under the guise of conglomerate energy companies. With prices appearing to have stabilized at a higher point than than those of the past couple of years, improved cash flows meant that the first half of 2017 saw M&A activity pick up substantially across the global oil and gas sector (USD 137 billion versus USD 87 billion in 1H 2016). Much of this focused on asset-based deals, adjusting upstream portfolios to achieve scale in core areas or reduce exposure in non-core areas.
An active start to 2017
The U.S. accounted for USD 42 billion of global M&A activity in 1H 2017, which was concentrated most starkly in the LTO producing Permian Basin, where 44 deals totaling USD 20 billion were realized. Entry positions in the Permian were staked out long ago. Operators there have moved on to focusing on add-ons that enhance existing development opportunities. Notable was a USD 3.2 billion 71,000 acre expansion by Noble Energy, which intends to increase production there and improve near-term cash flows. Indeed, much of the M&A activity in the Permian involved land acquisitions to rectify the patchwork landholding that limited some of the most efficient horizontal drilling, which can extend tens of kilometers. The result is likely to be more LTO production that is profitable at lower oil prices. The Marcellus Basin saw seven deals in 1H 2017 worth USD 10 billion, the most important the USD 8.2 billion purchase of Rice Energy by EQT Corporation. This prominent corporate-level deal focused on natural gas assets, making EQT the largest producer of natural gas in the U.S. and the dominant player in the Marcellus/Utica. As a result in the future EQT will be able to take a disciplined approach to asset management in line with market and infrastructure developments. When it comes to unconventional oil and gas production then, the story is largely one of existing operators consolidating their holdings to achieve efficiency improvements both in terms of technology use and portfolio management. While driven by existing players, those moves have been supported by private equity funding in both upstream and midstream deals. Private equity was involved in deals worth USD 13 billion in 1H 2017, investment focused primarily on the Permian. That has helped to facilitate consolidation in the midstream sector as asset rationalization may provide opportunities to offset the slowdown in organic growth in pipeline expansions.
The dynamism of the technology sector
M&A activity in the oil field services (OFS) sector also points to the rise of consolidation around specific technological capabilities. GE’s acquisition of Baker Hughes is a bid to create a business focused on more efficient well operations through automation, enhanced imaging, and data analysis. Ensco acquired Atwood Oceanics to strengthen its position in technologically advanced deep and shallow water offshore drilling. In March, Weatherford and Schlumberger announced the creation of OneStim, a joint venture combining their North American land hydraulic fracturing pressure pumping assets, multistage completions, and pump-down perforating businesses. And in the largest deal in the sector in 2017, Wood Group acquired AMEC Foster. The goal there was to reap the benefits of increased scale and a more diverse customer base. Tight margins and uncertainty among upstream projects encourages service providers to seek access to customers in other segments including power, refining, chemicals, and infrastructure.
Price and the evolution of U.S. oil & gas
Looking forward, future consolidation in the oil sector will be a product of stable prices. 2017’s accelerated M&A activity was partly a result of prices finally seeming to stabilize on the heels of the OPEC/non-OPEC deal. A price decline later this year or early in 2018 (as a result either of weakened Saudi/Russian solidarity or macroeconomic weakness affecting demand) could slow the pace of industry consolidation. Higher interest rates and the tightening of liquidity could have similar results. The oil and gas sector is undergoing an evolution. The era of consolidation under large, integrated and generalist energy companies is giving way to a situation where specialist leaders in specific and often technological aspects of the production process are pulling ahead of the pack, and growing as a result. In the future that will require new forms of collaboration that identify and leverage specializations to cooperatively exploit a variety of circumstances. Shifting coalitions of specialist leaders will favor different players at different points in the field lifecycle, rewarding those who are best equipped to extract value at each stage. When it comes to U.S. oil production, recent waves of consolidation better position producers to confront a long-term oil price band south of USD 60 per barrel. The price will be critical to determining U.S. output projections, but landholding consolidation in the Permian and long-reach lateral drilling will make many plays profitable even at USD 30 per barrel.
The growth of utilities and renewables
The utilities sector continues a longstanding trend toward greater consolidation. Rising costs have become the norm for utility planners, together with slowing consumer demand and increased regulatory costs. Even as the Trump administration moves against the Clean Power Plan, the industry is moving towards cleaner generation and more advanced transmission. Part of this is driven by customers themselves, who are demanding more in terms of technology (to monitor their usage and costs) and choice (to source power from clean sources). Scale can be key to providing these at greatest efficiency, and a June EY report found that 59 percent of power and utility executives intend to actively pursue an acquisition in the next year. As utilities face an evolving market, confronting technological, regulatory, and consumer demand changes, they realize that there are too many threats on the horizon to stand still with their monopoly business. Both Duke Energy and Southern Company spent a great deal of money in 2016 buying wind and solar projects and adding to their natural gas portfolios. With declining returns on regulated contracts renewable energy projects with long-term energy delivery contracts can provide predictable earnings. No wonder that transmission and distribution and renewable energy assets backed by power purchasing agreements dominated Q1 2017, accounting for 78 percent of the quarter’s M&A total. The popularity of renewable energy projects reflects a widespread acceptance that, despite current political winds, future value is in sustainable generation solutions. Just as reliance on public policy made a weak case for alternative energy in the past, companies cannot bet on Trump policies to favor legacy fuel sources or dirty generation methods when considering multi-decade investments. The writing is on the wall.
Confidence in a more stable future
The recent and significant uptick in M&A activity within the U.S. energy sector is a good sign of optimism at a time when the oil market is still not balanced, when U.S. politics are hostile to particular technologies, and when both OFS companies and utilities have been struggling. That optimism however is rooted in technological specialization that is unlocking new value in a difficult environment and proposing a sustainable future despite an industry slump. The companies that best extract that value are poised to become major players—even if they do not need to become "majors" as such.
*Phillip Cornell is a nonresident senior fellow at the Atlantic Council’s Global Energy Center. Prior to joining the Atlantic Council, Cornell was a senior corporate planning advisor to the Chairman and CEO of Saudi Aramco.