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US shale patch dealmaking stays sluggish

Several prominent deals have helped partially salvage M&A activity, but conditions still look gloomy

The Covid-19 pandemic has had a significant impact on M&A activity in the US shale sector. The pace of deal-making fell to its lowest level in ten years across the first half of 2020 as the WTI price went negative for the first time in history and global energy demand nosedived.

Deal-making recovered sharply in Q3 as several high-profile corporate moves helped buck the downward trend. Chevron completed a $13bn acquisition of US independent Noble Energy in July, the fourth-largest upstream deal in the last five years. The transaction represented over 60pc of the total value of M&A completed across the quarter.  

Noble’s Eastern Mediterranean portfolio was a core motivation for the merger. The company holds exploration blocks offshore Egypt adjacent to Chevron’s and, most importantly, a stake in the giant Leviathan and Tamar gas fields offshore Israel.

The plan is to ramp up production at the Israeli fields towards a long-term gross goal of 300mn bl/d oe. Noble and its partners achieved first production at Leviathan in December and are targeting Israel, Egypt and Jordan as markets for their gas. Internationally, Noble also holds several exploration blocks offshore Equatorial Guinea with further gas monetisation potential.

“Companies would rather pursue a Chapter 11 reorganisation than fire-sale their assets” Dittmar, Enverus

Domestically, the Noble merger helps boost Chevron’s onshore US asset base, particularly in the Permian. Both companies hold adjacent acreage in the basin, and Noble has assets in the DJ basin in Colorado and the Eagle Ford in Texas.

Hammering it out

The largest purely domestic US M&A deal announced in Q3 was the merger between US independents Devon Energy and WPX Energy. The enterprise value of the transaction was estimated at roughly $12bn, representing around a 27pc share of total M&A completed across the quarter.

The Delaware basin accounts for 60pc of the pro forma company’s merged assets. And only around 35pc of acreage leased in the Delaware is on federal land, reducing the impact of a win by Democrat Joe Biden in November’s US election should his administration halt onshore leases, as is widely expected.    

Like with most M&A activity announced in 2020, the pro forma business also has little near-term debt commitments. Only $43mn is projected before 2023, and there is strong company liquidity at $4.7bn.

The merger is expected to help cut $575mn in combined company spend by year-end 2021. Well productivity at the pro forma company is also industry-leading, with results around 40pc higher than the average industry competition. WPX has cut drilling costs by 34pc since 2018, while Devon has trimmed costs by 31pc.

And the business is targeting capital discipline whether or not the oil price recovers in 2021. If WTI lifts above $45/bl next year and remains there, the pro forma company is capping oil growth at up to 5pc, prioritising positive free cash flow (FCF).

The $1.7bn maintenance capital funding level has been set at a breakeven price of $33/bl but will generate 8pc FCF for an oil price of $40-45/bl, 20pc between $50-60/bl and 31pc above $60/bl. Heading into 2021, the pro forma company has around 130 drilled-but-uncompleted wells it can also tap into to sustain production.

Gas fuelling optimism

But beyond these two rare highlights, upstream M&A activity continues to be subdued. The value of total deal-making in the US rose to almost $21bn over the period, but the number of completed deals was still the lowest in 10 years, according to data from energy research firm Enverus.

The next two biggest deals were in Appalachia and the Gulf of Mexico. Natural gas producer Southwestern Energy acquired peer Montage Resources for $874mn in August. In the Gulf of Mexico, US firm San Juan Offshore purchased Texas-based driller Arena Energy for a reported $466mn following the latter’s filing for bankruptcy in August (see Fig. 1). 

For most of the year, gas acquisitions have had better traction than pure oil assets due to slightly more robust prices along the gas curve. The 12-month strip price lifted to $2.50/mn Btu in May, particularly benefiting deal-making in Appalachia.

$13bn — Chevron merger with Noble

“The forward curve is indicating natural gas prices well above $3[/mn Btu] next year,” says Hillary Cacanando, senior vice president at US broker Odeon Capital Group. “As a result, we would expect gas deals to continue to be more popular than oil deals, at least in the near term.” 

Historically, when the oil price has fallen below $50/bl liquids-focused deals started to slide. Thus, with WTI hovering near $40/bl and market volatility still high due to the coronavirus pandemic, liquids M&A activity is likely to remain impacted for the foreseeable future.

Too much to handle

Shale producers with high debt obligations have largely been snubbed by potential buyers, and the challenging economic conditions have hardly helped. “M&As so far have focused on companies with reasonable debt load, with those with impaired balance sheets having to file for bankruptcy protection instead of being acquired,” says Cacanando. US law firm Haynes and Boone estimates that there have been 40 US E&P bankruptcies this year, a level last seen in 2016.  

“Potential buyers do not necessarily want to take on substantial near-term debt repayment obligations, and that narrows the field of attractive merger partners,” says Andrew Dittmar, senior M&A analyst at Enverus. “If these companies cannot solve their balance sheet issues on their own, a Chapter 11 filing is going to be the end result.”

On the asset sales side, meeting debt obligations may spur some additional activity, but companies are likely to trim portfolios only if they can guarantee reasonable valuations in the market and can remain viable concerns post divestment. “From what we have seen, companies would rather pursue a Chapter 11 reorganisation than fire-sale their assets,” adds Dittmar.

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