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Is the oil, gas patch M&A hot streak here to stay?

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Jasmin Melvin:
Welcome to the Capitol Crude Podcast. I’m Jasmin Melvin. We’re just days into 2024 and there’s already a new multi-billion-dollar oil and gas deal to talk about. US oil producer APA announced on January 4th that it would buy rival shale oil driller Callon Petroleum for $4.5 billion, boosting its oil and gas presence in the Permian Basin and extending the hot streak of M&A deals in the oil patch. According to S&P Global Market Intelligence data, oil and gas deals topped $271 billion in value in 2023, more than doubling the value of deals made in 2022. What’s more is all this M&A activity is occurring under a murky economic picture characterized by inflation, high interest rates, and raised corporate borrowing costs.

Bruce On, EY’s energy strategy and transactions leader, join the podcast to discuss this wave of consolidation, whether it’ll continue and just how the oil sectors are managing to pull off these deals in uncertain economic times. He also gave his take on how the surge in deal making will play out and the role politics could play as the US gears up for a major election. Stick around after the interview for Binish Azhar with the Market Minute, a near-term look at oil market drivers. Now, here’s my conversation with EY’s Bruce On.

High inflation and rising interest rates don’t necessarily create the best environment for deal making and mergers and acquisitions, but the oil and gas sector saw a surge in M&A activity in 2023, notably with the Exxon and Chevron mega deals announced in October, and a few weeks ago in December, Occidental agreed to buy Crown Rock for $12 billion. Why and how is the oil space bucking the trend here?

Bruce On:
You’re absolutely right. Look, the year started off pretty slow with US M&A activity, but it actually showed signs in uptick with energy industry really being the bright spot throughout the year, and you noted the very mega deals that were announced and that we’re looking forward to closing in 2024. But in particular, as you think about from a deal perspective and these blockbuster deals, they’re really on the back of record profitability in the energy sector. I think if I look at it correctly, the energy stocks has outperformed the S&P 500 by about 54% since it started in 2022. That was driven a lot by surge of demand, but you had geopolitical tensions, but as well as you had an improved structural performance by the businesses, and this has allowed these deals to go through with their stock deals, the balance sheets are really strong at a lot of the energy companies, and so you’re seeing this realization by energy companies and this consolidation to be able to take place in our sector and drive further consolidation.

Jasmin Melvin:
Okay. So is there anything about these recent deals that sets them apart from past transactions in the oil fields?

Bruce On:
Yeah, absolutely. Look, we’ve gone through waves of consolidation in the past, but what I think is really different this time around is really driven by two things. One, you think about the strategic rationale behind some of these mega deals and what we’re also seeing in the consolidation that we’ve talked with other companies. It’s not just a play at efficiency through scale and driving down costs, but they’re really looking at technology efficiency and the ability to deploy technology the best of both companies and kind of driving down the cost, even do drilling and completion and getting the barrels out of the ground.

And then you also think about the lens through which a lot of our oil and gas companies are operating through energy transition. So you think about their ability to procure additional acreage and production and reserves, while also doing it while they think about their strategy in the low-carbon solution and low-carbon environment and their ability to achieve both objectives. And so, what I mean by that is you take a step back, think about the Permian Basin and it’s accounted for about 50%, I think, of all upstream M&A activity since 2021. A lot has to do with, yes, it has lower breakeven, it has a large amount of underdeveloped assets in there, but these are also short cycle assets that have a lower carbon intensity than other assets in the world. So you think about companies trying to find who are the best operators and match them up with those assets.

Jasmin Melvin:
And now kind of drilling a little more into the deals that we’re seeing right now, what would you say is the likelihood that these deals actually close, particularly ExxonMobil’s planned purchase of Pioneer Natural Resources and Chevron’s proposed buy of Hess? We’ve seen senators ask for investigations into these deals and the FTC has asked for more information about the transactions. Is this just procedural or is there concern that these deals could fall apart?

Bruce On:
Yeah, once again, a great question, Jasmin. Look, for any mega deal or very publicly announced and followed transaction, this is kind of standard part of execution of the deal. And so, especially in the current environment where you think about energy security, affordability, that’s top of mind for the US and our government, and so with companies that operate in the oil patch, which have steadily increased oil and gas production in response to strong global expansion, but there’s also supply disruption and geopolitical unrest, we expect these oil and gas companies to continue to seek these large acquisitions, even with the added scrutiny, if you want to call it that, that will come as they look to have consolidation in the market.

Jasmin Melvin:
Do you think this is the start of a consolidation wave? What would that mean for both the oil industry and for consumers at the pump?

Bruce On:
I’m not sure if it’s even just a start or the continuation of the consolidation within the oil patch. I think it’s always been going on. If you look historically over time, there’s always been consolidation, whether it’s swaps and/or bolt-on acquisitions. But we definitely do think that this trend will continue especially into 2024.

Look, even as a matter of fact, from an EY perspective, we deemed energy to be the sector to look out for M&A in 2024. We think the large E&P will continue to secure acreage, it’ll enhance their cash flow, and they’ll maximize returns via acquisition in addition to just traditional exploration. And so we view this as a very positive thing for the industry, as well as for the consumer. Because look, it creates the ability for these oil and gas producers to operate more efficiently, they’ll drive down the cost, which is positive for the consumer, they’ll be able to leverage scale, they’ll be able to leverage differentiated capabilities, and then also you think about how they strategically, they think about talent management and what’s going to happen in Houston and the other geographies that employ large percentage of their population that support the oil and gas industry.

Jasmin Melvin:
Kind of building on that a bit, the majors like Exxon and Chevron have billions of dollars in cash on their books, but haven’t touched it to make recent deals. Is that cash going to be used in more deals or somewhere else?

Bruce On:
Yeah. You know what? Really interesting, Jasmin, to see the strength of the balance sheet, and to also witness the discipline that these oil and gas companies are displaying currently. I think in the past they would be quick to ramp up production, use that cash for exploration, and continue development, but we’re really seeing a lot of discipline around this capital allocation and they’re sticking very closely to what they’re telling investors and stakeholders around how they’re going to deploy that capital and what the capital expenditures are going to be in a given year.

That being said, we’ve already seen some of the super majors on the back are heels of announcing their deals, increasing the amount of capital that will be deployed. But what’s interesting is they’re not just deploying it around their traditional business of oil and gas development and production, but they’re also looking at low carbon solutions and other technology or investments in that technology that’ll help them as they think about their strategy as they diversify their portfolio, not just in traditional oil and gas, but also in their energy transition businesses that each are looking to execute on and develop.

Jasmin Melvin:
With all these things going for the oil industry, is there a risk that the FTC’s aggressive antitrust actions could chill deal making in the oil and gas patch?

Bruce On:
Look, M&A is inevitable in the oil and gas sector, but because of that, it presents a lot of growth opportunities and natural synergies. And so navigating the antitrust environment, and there’s challenges there, but it also necessitates being strategic, being agile as our companies think about target identification, acquisition, and risk management.

So look, Jasmin, when we talk with the company leaders about their M&A strategy and as they start executing against that strategy, what we’re telling them is, “You might want to build in some extra time as you think about your deal process.” A lot of that time we want them to be spent on being more efficient and performing the upfront economic analysis to determine what antitrust risks might be involved and to help them avoid delays. Further, as the teams think about modeling deal integration, the scenarios, and the resulting synergies, we are helping them think through divestitures, think through the structural operating model on a post-close basis, and thinking about are there strategic offers that they would be willing to concede to, to be able to make sure that the deal goes through. So all these things are tools that most energy companies can use and deploy to make sure that they mitigate and manage the risk related to any antitrust issues that they see out there as they go about their deal making.

Jasmin Melvin:
And just because we have an election coming up, does that risk management get affected by politics and the fact that there may or may not be a change in administration?

Bruce On:
It’s really hard to tell, Jasmin, on how that’s going to change or not change. But what we do know is that the companies we’re working with, they’re preparing for that, they know that they are going to get questions. And look, a lot of times they’re good questions around how does it impact the consumer? The competitive landscape? And so these are things that the companies that we’re working with, they’re preparing for, they’re being open and honest in the dialogue around impacts to the marketplace. Now, whether that changes because of the political landscape, I know that it doesn’t change the end answer, and so as long as we’re being upfront and managing, as I discussed before, thinking about how do you manage that risk through preparation and thinking about the deal and in environment of the questions that they will get and the scrutiny they’ll receive, a lot of times that will mitigate and manage the risk appropriately.

Jasmin Melvin:
Okay, so I’ll be on the watch for the next big deal announcement. Thanks, Bruce, for joining me on the podcast.

Bruce On:
Thanks, Jasmin.

Jasmin Melvin:
Now, here’s the Market Minute with Binish Azhar.

Binish Azhar:
This week, market players will have plenty of key economic data to look forward to from the US, China, and the UK, which could help to alleviate or elevate inflation and recession woes, depending on the results. The S&P Global Investment Manager Index will uncover shifts in investor sentiment following a 2-year high in US equity investors’ risk appetite seen in December. Respondents of the IMI survey anticipate seeing gains for the S&P 500 by the end of 2024.

On Thursday, December CPI figures will offer insight on inflation in the US, with PMI prices data hinting at some stickiness at current levels given that inflation had cooled faster than expected during the tail end of 2023. Annual CPI inflation cooled in November to 3.1%, with the core rates stuck at 4%, according to S&P Global data. December headline and core CPI ratings are expected to inch up slightly from November. The data will be especially important as markets widely expect the US Federal Reserve to lower interest rates this year in order to continue the fight against inflation. Interest rate cuts are looking more likely, with markets now pricing in a 98% chance of the first cut happening by May 2024. For the upcoming January meeting, however, CME FedWatch Tool data shows a 93% probability that the Fed will leave rates unchanged.

In the UK, November GDP data will be released on Friday. According to early indications from the UK PMI, output rose in the final two months of the year, calming recession worries after the GDP fell 0.3% in October. Also on Friday, China will see results from the December CPI and PPI data, with subdued inflation conditions signaled for the manufacturing sector according to the Caixin PMI. While the country continues on its path to economic recovery, expansion is expected to remain at a modest pace in 2024. The headline seasonally adjusted Caixin General Manufacturing PMI increased from 50.7 in November to 50.8 in December, showing a marginal positive expansion in manufacturing conditions.

Jasmin Melvin:
Thanks, Binish. That’s it for today, but don’t be shy about letting us know what topics you want to know more about. Get in touch. Kate and I are on Twitter, so drop us a line at @JasminMelvin or at @KateAnnWinston. And if you like what you hear, please consider leaving a review on your favorite podcast app. Capitol Crude is produced by Jasmin Melvin and Kate Winston in Washington DC and Jennifer Pedrick in Houston. Thanks for listening and we’ll see you next time.

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