What’s Driving Merger Mania in the Oil Patch?

A lot of money has been committed to mergers and takeovers in the oil & gas industry in just the past week.

The first deal was the $1.7 billion merger between Denbury Resources Inc. (NYSE: DNR) and Penn Virginia Corp. (NASDAQ: PVAC) announced on Monday. The next day Chesapeake Energy Corp. (NYSE: CHK) revealed an offer of $4 billion for WildHorse Resource Development Corp. (NYSE: WRD) and Thursday saw the biggest offer of all: Encana Corp. (NYSE: ECA) will pay $5.5 billion for Newfield Exploration Co. (NYSE: NFX) and assume $2.2 billion in Newfield’s debt.

Earlier in the third quarter, BP plc (NYSE: BP) paid $10.5 billion for all the U.S. shale assets owned by BHP Billiton plc (NYSE: BBL), the biggest oil patch deal of all so far this year.

What’s driving the merger and acquisition machine? One big reason is a company’s balance sheet. Smaller companies may have trouble maintaining a strong balance sheet as they continue to invest (by borrowing) in more exploration and production.

Rising interest rates make debt service from cash flows more difficult and without the scale and efficiency of a larger company, costs cannot be wrung out fast enough to maintain both debt service and increased production.

Shareholders rarely respond positively to companies that buy up other companies because they would rather see purchasing businesses maintain financial discipline in order to generate additional free cash flow that can then be returned to shareholders by means of higher dividends or share buybacks. Long-term strategic shifts, like Chesapeake’s acquisition to lift the higher-margin liquids share of its overall production, are particularly unwelcome.

According to a report in the Journal of Petroleum Technology, at last week’s Deloitte Oil and Gas Conference, Andrew T. Calder of the Kirkland and Ellis law firm told the assembled crowd:

Read More Here...

Bookmark the permalink.