Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

It isn’t just Wall Street that could do with a few more mergers in the oil patch -- OPEC could, too.

There’s a curious lack of deals in the U.S. exploration and production sector. Some $42 billion worth have been announced or completed thus far this year, according to data compiled by Bloomberg. Unless someone is planning on ruining Thanksgiving or Christmas for some junior oil bankers, 2015 looks to be the slowest for U.S. upstream deals since 2008 (when everyone’s holidays got ruined).

That pace must pick up, given where oil and gas prices are and the pressure building on smaller, highly indebted E&P firms. And when bigger predators finally pounce, it will rightly be read as bullish for oil prices.

It won’t be just the optics, either; Big Oil could actually boost oil prices just by doing some deals.

Look at the two biggest recent U.S. deals by Exxon Mobil and Chevron, the acquisitions of XTO Energy and Atlas Energy, respectively. Buying XTO made Exxon the biggest producer of natural gas in the U.S. The Atlas deal wasn’t as transformational for Chevron -- that deal was worth just $4.9 billion, versus $41.4 billion for XTO -- but it helped boost the company’s proven U.S. gas reserves by almost half.

Yet you’d hardly know that from looking at the chart below. Sure, Exxon’s U.S. gas output jumped in 2011 with XTO on board, but it has fallen by 13 percent since then. Atlas didn’t register at all for Chevron, and its U.S. gas production has also declined.

 

gas chart

This illustrates perfectly how the majors differ from their smaller brethren. Investors usually buy E&P stocks for growth, which is precisely why the sector fracked its way to a revival in U.S. oil and gas output. In the three years prior to 2010 -- when Exxon closed its deal and Chevron announced its own -- XTO’s production jumped by 61 percent and Atlas’ rose 17 percent.

The majors, being behemoths already, are valued less for growth and more for their return on investment. With U.S. gas prices on the floor but expected to rise at some point, it makes sense to sit on the resource rather than pump it out now. The majors also have a lot to learn when it comes to shale development, where they got schooled by the smaller firms.

Exxon CEO Rex Tillerson spelled out his thinking about XTO at the company’s analyst day in 2012:

We can be patient. We don't have to make a lot of money out of [XTO's resource base] right now. We're going to make a lot of money out of it in the years to come, and we're going to do that because we're going to have an approach and we're going to understand it better than anyone else does.

This sanguine expression of investing genius rather ignores the fact that Exxon’s timing was off: It announced the XTO deal when gas traded above $5 per million British thermal units, more than double the current price. What’s done is done, though.

The key point is that Exxon has been gathering U.S. gas assets while striving to become more efficient in how it exploits them. Like all the majors, it ranks its U.S. shale prospects against all the other potential investment projects it has around the world. Little wonder that it hasn’t been pushing dollars toward getting more gas out of the ground just so it can sell it at lousy prices.

All of which is why consolidation will be critical to a sustainable recovery in oil prices. Without it, smaller companies focused on growth will simply put rigs back to work as soon as prices allow, capping any rally. One of OPEC’s objectives is to force higher-cost producers out of the market. It can’t uninvent the shale breakthrough. It probably can, though, force some shale operators to sell their assets to companies with bigger portfolios, where they may sit idle for years. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net