It would have been surprising, given how deeply the shale revolution has reshaped every facet of the oil and gas markets, if this hurricane had not also left its mark on the corporate landscape. In the ten years or so since shale technology really started kicking up dust and taking the market by storm, the small U.S. independents initially involved have gotten bigger and become household names and the darlings of the stock market. They have merged with one another, traded assets, cut costs, revamped their portfolios-when they have not folded. In the process, they have helped revolutionize financial engineering for oil and gas as sweepingly as they have transformed hydrocarbon extraction technologies and upended the old business model of Big Oil (and gas) companies. The dust has yet to settle. From Pennsylvania to North Dakota to West Texas and New Mexico, the winds of change are blowing through the U.S. oil and gas patch. There are as many open questions about shale’s ultimate impact on mergers and acquisitions (M&A) as there are about its effect on oil and gas prices, market volatility and the future of oil and gas markets more generally.
The "American energy domain"
By unlocking vast subsoil resources previously deemed uneconomical, shale technology has swept away old fears of resource scarcity and, in the U.S., energy dependence, and replaced them with a heady feeling of abundance and, in President Trump’s lingo, American "energy dominance" (whatever that might mean). Thanks to shale’s success story, the United States has logged the steepest production growth in oil history. That U.S. shale oil, despite such spectacular growth, only accounts for about 5 percent of world production is beside the point. Its short business cycle and low capital requirements have shaken OPEC and the Majors to the core. Surging shale supply has helped trigger one of the steepest and longest oil price corrections in memory. Shale has rocked the M&A world. Shale has not only put the Marcellus, Eagle Ford, Niobrara, Haynesville and Anadarko basins on the U.S. M&A map, it has made them a focus of activity on a global scale. In 2012, U.S. acquisitions reached about USD 95 billion, led by such shale-focused deals as mining giant Freeport-McMoRan’s purchase of Plains E&P for USD 16.8 billion and Access Industries’ acquisitions of EP Energy shale assets for over USD 7 billion. Transactions dipped to USD 60 billion the following year, only to bounce back to north of USD 95 billion, a new record, in 2014. With the short cycle and high performance of shale oil and gas making it increasingly tricky to invest in longer-term, big-ticket projects, the growing U.S. shale patch became the place to invest. Oil and gas M&A activity took a hit from the oil price collapse of 2014-15 in the United States as elsewhere, as companies cut spending in a hurry. In 2015, transactions dropped to about USD 35 billion. Yet U.S. shale remained a deal magnet and helped the United States navigate the downturn more smoothly than others. In 2015, shale oil assets continued to dominate M&A activity, led by Noble Energy’s USD 3.8 billion acquisition of Rosetta Resources, with assets in the Eagle Ford and Permian Basin, WPX’s USD 2.7 billion purchase of First Reserve (Delaware Basin) and Devon Energy’s absorption of EnCap, with assets mainly in the Anadarko. In the two years that followed the 2014 price collapse, the United States accounted for about 30% of global deal value, more than twice its share of liquids production (excluding ethanol and processing gains) and much more than its share of natural gas supply. Indeed, in 2016, U.S. M&A activity noticeably diverged from underlying market trends and posted steady quarter-on-quarter gains extending into the first quarter of 2017, with most of the deals focused on the Permian Basin, even as oil prices struggled to hold on to a short-lived, late 2016 recovery. Against the background of virtually no big oil project being sanctioned anywhere and exceptionally few oil discoveries, this renewed appetite for deal-making brought U.S. transactions back up to almost USD 70 billion in 2016, and USD 39 billion in the first half of 2017. Most of the latter deals were front-loaded in the first quarter. Then M&A activity in the US shale patch came to a screeching halt.
The history of the last years of assets and strategies
While the rise of U.S. shale oil and gas is the overarching narrative running through much of the U.S.-and indeed global-M&A activity of the last few years, that headline story conceals large shifts in the type of deals, asset size and quality, location, cast of characters and strategic rationale of the transactions. The history of the shale craze is a play in five acts.
Act I is the time of the pioneers, when shale companies were still in their infancy. Measured in deal size, this heroic age doesn’t quite yet register. This is the archetypal rags-to-riches story, an epic of risk-taking, persistence and ingenuity leading to untold rewards, a high-tech remake of the Rockefeller founding myth. Its self-made heroes are Rocky Balboas of the oil patch: George Mitchell, Harold Hamm, Mark Papa… This is the stuff of breezy page-turners like Gregory Zuckerman’s The Frackers and Russell Gold’s The Boom. There is an acquisition side, as well as a technical side, to this story: Zuckerman and Gold tell how competing "frackers" raced to build up a critical mass of drilling rights in fragmented parcels from individual landowners in promising plays. But the point was to keep things quiet and valuations down, so in transaction terms, these piecemeal deals are just a footnote in M&A history.
Act II marks a change of pace, a golden age of frenzied deal-making and rising premiums against the background of the commodity super-cycle and widespread perception of an endless bull market. "The age of easy oil is over" is the mantra of the day as confidence grows that oil prices will never again fall below $100/barrel. Shale’s success, first in natural gas, then in oil, takes center stage, quickly crowding out other prospects. Major oil companies jump on the bandwagon and prove more than willing to pay through the nose: ExxonMobil famously agrees to fork out USD 41 billion in stock for shale-gas producer XTO Energy in a deal completed roughly two years before spot Henry Hub prices plunge below USD 2/million Btu in 2012. Exxon’s then CEO Rex Tillerson later admits that the deal had been poorly timed. His successor Darren Woods more recently conceded that its price tag, despite a partial recovery in gas prices, had been steep. As weak gas prices prod producers to move to liquids, deal making increasingly turns to oil. The Bakken, which boasts a relatively low percentage of associated gas, is a first focus. A milestone is reached when North Dakota production first tops 1 million bpd in 2014. Harold Hamm’s Continental Resources is in the lead, having built up acreage and morphed from small-cap into heavyweight through leasing, strategic trades and small acquisitions. Whiting Petroleum challenges it in production volumes if not acreage with the USD 6 billion takeover of a Bakken pure-play, Kodiak Oil & Gas, announced in July 2014. Earlier deals include Statoil’s 2011 purchase of Brigham Exploration for USD 4.7 billion; Exxon’s $2 billion acquisition of Denbury Resources’ Bakken assets and Halcon Resources’ USD 1.45 billion purchase of Bakken assets from PetroHunt in 2012; and Oasis Petroleum’s 2013 takeover of Bakken assets from Roda Drilling and Zeneco also for USD 1.45 billion. Soon the Eagle Ford of South Texas takes over as the fastest rising producer and most active M&A play. Whereas the Bakken lacks takeaway capacity and suffers from a deepening crude price discount to benchmark WTI, the Eagle Ford enjoys more favorable logistics and access to Gulf Coast refineries. Its high condensate content works out well before the December 2015 lifting of U.S. restrictions on crude oil exports, as condensate escapes the export ban. The steep premium paid by Canada’s Baytex Energy for its USD 2.6 billion acquisition of Aurora Oil and Gas in 2014 helps consecrate the play’s ascent, following on the heels of Devon Energy’s entry into the field with its USD 6 billion purchase of GeoSouthern. Another Canadian producer, Encana, pays USD 3.1 billion in 2014 for conglomerate Freeport-McMoRan’s Eagle Ford assets. For both Devon and Encana, the deals are part of a strategic move away from gas. Earlier, U.S. E&P Marathon Oil had bought Eagle Ford acreage from Hilcorp and private equity firm KKR for USD 3.5 billion in 2011. Several foreign oil companies use U.S. joint-ventures to buy into the play in 2010 and 2011: China’s CNOOC with Chesapeake Energy, Korea’s KNOC with Anadarko Petroleum, Norway’s Statoil and Canada’s Talisman with private firm Enduring Resources, and India’s Reliance with Pioneer Natural Resources.
The third act dof the U.S. M&A play starts when oil prices head south in June 2014. Thanks to the industry’s ingenuity, production has grown at break-neck pace, turning shale into a victim of its own success. As oil markets fall, so does global M&A activity, which hits its lowest level in more than a year in 3Q2014, both in the number of deals and total value. U.S. M&A activity stays on track for its strongest showing in six years, though. Encana buys Permian player Athlon Energy for nearly USD 7 billion, on top of Whiting’s USD 6 billion Kodiak deal. As signs of "lower-for-longer" prices take hold of the oil market in late 2014-early 2015, U.S. M&A activity continues to diverge from global trends, but the deals start changing. While many U.S. buyers had aimed to capture the upside of an everlasting bull market, in the downturn U.S. investments turn defensive. In most U.S. plays, drilling activity edges down as lower oil prices trim budgets. The Permian Basin bucks the trend and emerges as the sector’s biggest success story. Well productivity improves as extraction techniques keep getting better and producers generalize high-performing horizontal wells. While shale "resilience" and fast adaptation to lower prices generally surprises, the Permian Basin outperforms all others and becomes the new magnet of M&A activity, attracting top dollar. Elsewhere, belt-tightening is the main driver: exposure to the commodity boom gives way to consolidation to keep expenses down and streamline operations by combining contiguous assets. Multiple M&A rounds thus see EQT Corporation emerge as the top U.S. gas producer in 1H2017 following its USD 8.24 billion purchase of Rice Energy, which itself had bought Vantage Energy the previous year for USD 2.77 billion. The deal brings together two leading Marcellus and Utica operators in a bid to optimize gas drilling. Unveiling the deal, EQT first says it will save USD 2.5 billion in costs, then points to another USD 7.5 billion in synergies.
Act IV. A flurry of Permian transactions in late 2016 and early 2017 soon fizzle, however, ushering in Act IV. Ten years into the boom, deals suddenly are few and far between, with just USD 2.5 billion in Permian deal value in 2Q17, and no single deal above USD 1 billion. Investment migrates back to the Marcellus. Both total transaction values and the number of deals drop further in the third quarter, a plunge analysts blame on OPEC’s seeming inability to shore up oil prices. That is just part of the story, however. Equally significant may be the market’s eroding confidence in shale’s growth potential. After years of cost cutting and aggressive consolidation, the sector is running out of improvement options. Well productivity gains reversed in mid-2016 amid mounting signs of congestion and cost inflation. Production growth has slowed. Even in the Permian, there are signs of headwinds. Assets have become pricey. Second-quarter corporate earnings have disappointed. Permian gas-oil ratios are rising, and some companies have lowered their guidance. Some investors are talking publicly about shorting shale stocks. While it is too early to tell how long the fourth act will last, the mood swing is tangible.
Predictions are still difficult
Act V has yet to be written. What could bring an end to the current lull in U.S. M&A deals? Several scenarios can be imagined, all of which likely require a realignment of shale valuations and crude markets. That could come through either a recovery in underlying oil markets or a downturn in shale assets. After three years of low capital spending, non-shale oil and gas production seems set to decline, paving the way for a supply shortfall. Meanwhile, despite growing speculation about “peak oil demand,‘ consumption growth is robust. Political risk has never been higher. A price rebound, perhaps as surprising to many market participants as the collapse had been three years ago, could trigger the next major round of M&A activity and provide private equity firms, which play an increasingly large role in the shale patch, with the exit opportunity they need. Absent an oil price recovery, a new round of efficiency gains could rekindle investor appetite. Shale companies, facing diminishing access to financing, could mark down their assets. Alternatively, national oil companies (NOCs) could make a new bid for shale properties. At the time of writing, there were unconfirmed reports of Saudi interest in U.S. shale gas assets. In all scenarios, buying interest might be ready to move away from its strong shale focus of the last few years. Shale resources will certainly remain an essential part of the supply mix for decades. As the sector matures and markets continue to rebalance, however, their disruptive effect might start to fade, and investment might partly migrate back to longer-term, capital-intensive projects.
Antoine Halff runs the oil program at Columbia University’s Center on Global Energy Policy and is a co-founder of Kayrros, having been chief oil analyst of the International Energy Agency, lead economist at the U.S. Energy Information Administration, head of commodities research at Newedge and director of Eurasia Group’s energy practice. Bill Clinton called his book, Energy Poverty, a "must-read."