The upstream products of the energy industry (crude oil, natural gas, and NGL) are raw materials, so lower-cost producers generally do better, especially if they are well connected to downstream markets. Due in large part to intense competition, finite drilling locations, the constant need for capital investment, and the heating effect of political headwinds, the industry is in the midst of a cycle of consolidation that has allowed a select group of top-tier E&Ps to build scale (and longer-lasting inventories) in the most productive parts of the most lucrative shale plays. This scale, in turn, helps these Shale Era winners lower their costs, gain market share and, importantly in 2023 and beyond, return a large portion of their free cash flow to investors as dividends and buybacks of shares In today’s RBN blog, we discuss what’s driving this “impulse to merge” and what it means for industry players, big and small.
Mergers and acquisitions (M&A) cycles often play out like a high school dance. It starts with the prom king and queen, and then the most desirable dance partners are taken. Ultimately, the last people to dance are the ones who were too slow to ask and now they have to react and accept those who are still left, or end up looking out.
M&A cycles that follow this pattern are nothing new in the energy industry. The “Super-Major Era” in the early 2000s began with Exxon’s merger with Mobil in 1999. This consolidation focused on improving the return on invested capital (ROIC) of the combined business. After the ExxonMobil merger, a series of acquisitions followed: BP/Amoco/Arco, Total/Fina/Elf, Chevron/Texaco, and the unification of Royal Dutch and Shell. The goal was the same: scale is important and energy companies must deliver a higher ROIC to attract investment dollars. Since the best matches tend to appear early in the consolidation cycle, the pool of potential partners shrinks as time goes on, with targets chosen more for availability and less for attractiveness.
These companies dominated the field for American producers as domestic supplies dwindled before the shale revolution. So much has changed in the past 15 years that it can be hard to remember how different the American manufacturing landscape was before that. Most of the domestic production comes from the Gulf of Mexico, in addition to the North Slope of Alaska, Texas and California. However, as horizontal drilling and hydraulic fracturing took center stage, new areas opened up and the number of rigs per state and the number of states with active drilling multiplied.
