Share Price Fall Fuels Takeover Interest

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The sharp decline in North American natural gas prices since the start of the year has softened up share prices of most independent producers to the point that many are now viewed as attractive takeover targets for larger, cash-rich players. While it is still unequivocally a seller's market in the US and Canada, peak prices for upstream oil and gas assets may have passed, opening the door for more growth-oriented corporate acquisitions. US gas prices have fallen from record highs of around $10 per million Btu at the beginning of the year to around $3/MMBtu recently. Share prices of most exploration and production companies have followed in tow, with many leading firms now showing year-to-date declines of 20%-40% (PIW Jul.23,p1). After a flurry of expensive deals shook North America's upstream sector in the first half of this year, the pace of deal making has slowed in the third quarter. Buyers have been more cautious about paying up for upstream assets amid uncertainty about where the bottom of the natural gas market lies. According to consultants John S. Herold, 64 significant upstream deals worth a combined $26 billion were announced in the US and Canada in the first half of the year. Prior to Devon's $8 billion buying spree, only a dozen deals amounting to less than $5 billion have been announced in the third quarter. Unable to ascertain where gas prices will settle, buyers have been spurning sellers' high asking prices and reserve values are gradually coming down. After averaging more than $8 per barrel of oil equivalent in the first half, US reserve values have fallen to the $7/boe range in the third quarter. Reserve values in Canada, which averaged about US$7.75/boe in the first half, have dropped to an average of $6.40/boe this quarter (PIW Jun.4,p1). Signs have emerged that the shopping spree in North America may resume soon, however. Devon's $3.5 billion acquisition of Mitchell Energy and $4.6 billion purchase of Calgary-based Anderson Exploration points to this, as it shows faith in the long-term strength of gas prices. Investment bankers say that companies have struggled to grow production through the drill bit and are looking to acquire new gas reserves and output in anticipation of a "gas-to-power boom." Utilities, power generators, and pipeline companies could also become active asset buyers to gain physical control of reserves to feed their plants (PIW May28,p5). In the weeks before announcing the Mitchell deal, Devon said its cash would be better spent on a large share repurchase than an over-priced acquisition. Before the deal was made public, Mitchell shares showed a year-to-date loss of about 25%, perhaps prompting Devon to change its tune. The acquisition of Anderson last week makes Devon the largest independent producer of oil and gas in North America. Cheaper independent producers could be easy prey for cash-rich integrated oil companies, many of which are struggling to hit their upstream goals (PIW Aug.20,p3). After failing in bids for US Barrett and Australia's Woodside earlier this year, Royal Dutch/Shell is believed to be on the prowl again. Marathon Oil -- one of the few US integrated oil firms not to make a major upstream acquisition over the past two years -- is scouring the asset market. Brazil's Petrobras is also looking to buy a US independent. Although it has actively repurchased shares to soak up excess cash, Shell was still sitting on roughly $9.5 billion in cash midyear. Marathon Chief Executive Clarence Cazalot, who concedes that his company's performance in reserve replacement and production growth has been poor in recent years, says the firm has "kept its powder dry" for potential acquisitions. Petrobras is the Gulf of Mexico in an effort to meet its foreign production goal of 300,000 b/d by 2005. In the US, Ocean, Unocal, Pioneer, Burlington, and Louis Dreyfus are the largest companies seen as potential targets. In Canada, where US firms have already feasted on many top independents, Rio Alto is viewed as a leading candidate for takeover. Rocky Mountain independents continue to be prime candidates in the US as well, with Evergreen, Tom Brown, and Western Gas mentioned frequently (PIW Aug.27,p5). Takeover speculation has also surrounded Chesapeake and Cabot. Some junior producers in Western Canada have put themselves up for sale, including Allied Oil & Gas, Campion, Piper, and Ventus.

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