The next wave of M&A activity: North American shale gas
The shale-gas revolution that started with the drillers is entering the boardrooms. Expect the North American natural gas scene to look very different in coming years, writes Derek Brower
EXXONMOBIL, admits one of its spokesmen, is a company of few words. He might have added few risks. It is an approach that allows it consistently to outperform its rivals. But when ExxonMobil comes to the table, it plays big.
The acquisition of XTO Energy for $41bn in December will not make anyone's list for deal of the century, as Exxon's take-over of Mobil in the late 1990s did. But the news landed with an emphatic thump on the North American energy industry, and heralds what may be a new wave of consolidation among the continent's independent oil and gas sector.
The majors have been sluggish participants in what BP boss Tony Hayward calls the shale-gas "revolution" (PE 11/09 p22), but that is changing. Having watched ExxonMobil buy XTO, France's Total last month signed a $2.25bn deal to buy into 25% of Chesapeake Energy's Barnett Shale position in northern Texas. Chesapeake, one of the most successful unconventional gas drillers (PE 8/09 p24), says it might do another similar deal with Total in the Eagleford Shale gasfield in the south of Texas.
Cash needy, indebted and over-extended, the firm's strategy is to pursue joint ventures that can pay for its shale-gas ticket. BP signed a $1.9bn deal similar to Total's for a 25% stake in Chesapeake's Fayetteville Shale assets, in Arkansas, in 2008. Chesapeake followed that up with another, larger ($3.37bn) transaction that brought Statoil into its Marcellus Shale acreage, in the Appalachian region of the US northeast.
Those are deals that have brought the majors in contact with shale gas through the back door. Just as national oil companies once used partnerships with the Western firms to access their capital and learn from their experts, so recently have the majors sought to piggyback their way into the North American unconventional-gas business.
Even ExxonMobil implicitly admitted that in purchasing XTO it would keep the wizards at work: XTO would continue to operate out of its own offices in Fort Worth, Texas, and ExxonMobil would create an entirely new upstream division to focus on unconventional resources.
Not all of the companies already operating in the shale-gas sector share Chesapeake's strategy of funding operations through joint ventures. And few of them are likely to spend heavily buying rivals. The resource and the acreage are still plentiful, so there is little need yet to buy reserves from competitors; and many of them are carrying debts and seeking first to master lean production models that will cope with a potentially long period of low gas prices.
So the deal-making is likely to come from on high. BP, say the rumours, has considered buying Chesapeake. Range Resources, another company that has mastered the shale, has seen its share price rise by more than 2,000% in the past decade. It has become a standard stock pick for speculators seeking the next take-over target in the US gas world. Both of those companies are heavily balanced – critics say unbalanced – towards unconventional-gas plays. That makes them specialists, but it also leaves them exposed to the price of natural gas. Both factors make them good targets for the majors.
Indeed, two approaches are emerging among the independents seeking value in shale gas. The first, characterised by companies such as Canada's Talisman – which holds shale-gas acreage in Marcellus, as well as in Canada, in British Columbia's Montney play and another promising formation in Quebec, Utica – is using its conventional oil production in places such as the North Sea to generate cash flow for its more prospective unconventional-gas business. That also allows the company to hedge between two commodities and two markets. Its executives say, half in jest, that it means they worry about both the crude price and the gas price. Analysts say it is a clever balance.
It also makes the company less easy to digest for any acquisitive major, although that has not stopped the rumour mill from speculating about potential suitors for Talisman either. Chinese investors failed to materialise when reports of interest from China National Offshore Oil Corporation circulated in 2008. But its decision to focus on shale gas in North America has pitched it into the ring of targets again.
Meanwhile, companies such as Canada's EnCana, a big shale-gas acreage holder, are pursuing a different strategy. That firm recently hived off its oil business into a new company, Cenovus (PE 11/09 p27). EnCana kept the unconventional gas business. The split added value for shareholders: the combined market value of the two companies is now about C$10bn more than EnCana's was before the split. And the move has garnered much praise for turning EnCana into a "pure play" unconventional natural gas producer.
But like Range and Chesapeake, it also leaves EnCana hoping the shale-gas revolution reaches consumers in the US market. And it makes EnCana another potentially juicy morsel for a greedy major, although the company believes the split has had the opposite effect, making it more resistible to a take over. Analysts have compared its pure-play strategy and size with XTO. And we know what happened there.
Devon Energy, another Barnett Shale developer, but whose assets also include unconventional oil in Canada and an overseas business, is also a target, say analysts. At a market valuation of around $32bn – and a price tag that would naturally exceed that – it would not come cheap, especially as the offer would need to convince some of the company's long-standing and large individual investors. And Devon's position as one of the most established shale-gas developers would make any take-over more momentous than ExxonMobil's XTO deal. Like other players it is looking to divest non-core assets to focus on shale, suggesting that it is not looking for value from a merger.
With several of the shale-gas independents valued in a similar range (see Table 1), is there anything that can interfere with a new wave of consolidation in the North American natural gas sector?
One source of hesitancy, although evidently not for ExxonMobil, remains the natural gas market. Most of the players say quality shale-gas acreage is now economically viable when gas prices are around $5/m Btu. But memories of last summer's dip to about half that price have not dissipated and there are plenty of reasons to expect the market to remain weak (see Figure 5, p38). US natural gas stocks remain ample, despite a recent cold snap, and shale production continues to ramp up.
Moreover, expectations for US consumption growth do not yet account for the abundance of supply and what that might do to stimulate demand. A preview of the US Energy Information Administration's (EIA) Annual Energy Outlook has upwardly revised its demand forecast – but it is not spectacular. Consumption will even fall to 21.3 trillion cubic feet a year (cf/y) by 2014, it says, before increasing "gradually" to 24.3 trillion cf/y in 2030 and 24.9 trillion cf/y in 2035.
That consumption forecast barely exceeds the rise the EIA expects in coal demand and certainly does not support theories about a widespread gasification of the US economy. The forecast for price – slow growth to just over $8.00/m Btu (in 2008 dollars) – is even more alarming for investors betting on the shale-gas revolution. That modest price expectation, says the EIA, is a result of all the new shale-gas production it expects. The upstream success of these companies, in other words, could undermine the value of their product. As one executive from Talisman puts it: "Be careful what you wish for."
So does that make ExxonMobil's move for XTO an expensive mistake? The answer to that yields a great irony that is only now emerging in the North American energy sector. After years of lobbying hard against climate-change legislation that would put a price on carbon (see p24), oil and gas companies are now finding that such laws could be the gas sector's biggest friend.
A battle is emerging between the powerful coal lobby in the US and those representing the natural gas sector, including some companies with oil assets, including oil-sands ones. ExxonMobil's purchase of XTO suggests that even the company most associated with big oil's resistance, historically at least, to measures countering climate change could now see a price on carbon as a means of ensuring that abundant gas reserves are competitive with coal for power generation.
At the lower end of prices in North America – say, $4/m Btu –gas can compete with coal, says one gas-industry executive. When the price exceeds $7/m Btu, it probably cannot. Given the bearish forces affecting North American gas markets, putting a price on carbon could be the difference between natural gas becoming the "transition fuel", as some in the sector describe its role in the 21st Century, or remaining a fuel with only a sedate growth trajectory ahead of it.
The prospects of new US climate-change laws stimulating the natural gas sector were, however, dimmed last month in the wake of Republican Scott Brown's victory in an election to replace the late Ted Kennedy's Massachusetts seat in the US Senate. Massachusetts is not one of the coal-rich states, but the Republican victory has ended the super-majority President Barack Obama has enjoyed in the Senate (whereby the Democrat party ostensibly controlled the Senate).
That means Obama faces more difficulties passing legislation on controversial topics, including climate change. The proposed cap-and-trade system in the Waxman-Markey Act, also known as the American Clean Energy and Security Act, which has hung over the North American energy sector since it hit the books last summer, now looks politically improbable. Laws to introduce a cap-and-trade system in the US, a fundamental step in making natural gas a competitor with coal in power generation, now seem unlikely before 2013, at best.
As these new politics filter through to the unconventional-gas sector, there may be reason for some hesitancy among the prospective buyers. More speculative plans to gasify the US transportation sector (PE 9/09 p18) – a strategy advocated by some shale-gas players such as EnCana, as well as the mega-investor T Boone Pickens – look even further from the thoughts of lawmakers in Washington.
Yet the fundamentals persist. Gas is now abundant in North America in ways never expected and the country's oil dependence remains its most pressing long-term hydrocarbons problem. Gasification of the US economy makes sense, even without progress on climate-change legislation (see p25). In buying XTO, ExxonMobil has laid down a marker for the direction it expects the energy industry to take. It would be odd if other majors did not follow. Big oil is getting gassier. It will bring consolidation in the North American oil and gas sector – and could transform the world's energy industry.