Conoco Deal Previews Industry Consolidation Needs

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The global oil patch has recognized it must get much smaller if it has any chance to thrive in the uncertain decades ahead. That reordering is likely to be messy and drawn out. But US companies, stressed by shale's high decline rates and ongoing capital calls, are stepping up to lead the charge. Consolidation will be one path toward a smaller oil sector, alongside bankruptcies, investor exits and continued capital austerity. Consolidation can take many forms, but oil executives and financial experts made clear during last week’s Energy Intelligence Forum that it will not consist of scouring for heavily distressed assets as a means to grow on the cheap. Rather, consolidation will take place to add scale, improve efficiency, and high grade selective investment programs around the most resilient assets (EIF Sep.23'20). This motivation is exactly what is on display in this week’s $13 billion tie-up between ConocoPhillips and Permian Basin pure play Concho Resources. "[Concho CEO Tim] Leach and I both agree that sector consolidation is both necessary and inevitable," Conoco Chief Ryan Lance said, adding that these needs stretch to both improving returns and managing rising environmental, social and governance (ESG) challenges. The Bigger, the Better What is notable -- and sobering, perhaps -- is the degree of scale viewed as necessary to deliver. As with Noble Energy's decision to sell out to Chevron earlier this year, the Conoco-Concho marriage has ended with a leading E&P opting to exit rather than be a consolidator itself. In Concho's case, its investment-grade balance sheet and robust inventory of low-cost Permian shale assets meant it could command a 15% premium in an all-stock deal at a time when most deals only happen at low to no premium. At the same time, its shares have traded this year at levels not seen in a decade. During the second half of 2019, the average premium paid for corporate acquisitions was 40%. The decision to sell rather than buy came from the recognition that the slow-burn market recovery and rising ESG pressures likely mean shareholders are better insulated under Conoco’s wing. Leach acknowledged that a company with an underlying decline rate approaching 40% makes it extremely difficult to distribute cash back to shareholders. A combined Conoco-Concho faces a 12% average decline rate over the next decade, speaking to the advantage diversified portfolios, especially those comprised of minimal decline assets like oil sands and LNG. Conoco has pledged to cap reinvestment at 70% of operating cash flows to ensure robust shareholder returns. The company recently reinstated $1 billion in share buybacks for the fourth quarter, having suspended the program briefly. Conoco pays a 5%-plus dividend yield compared to a 1.7% yield at Concho. As for meeting rising ESG demands, Conoco married the acquisition announcement with more stringent Scope 1-2 (i.e. operational) emissions intensity reduction targets for 2030 and net-zero operational emissions by 2050 -- the first US producer to do so. Portfolio Resiliency For Conoco, the deal essentially supplants its new venture frontier exploration program, with $250 million dropping from its go-forward annual exploration spending. Conoco executives have long been open to acquisitions so long as the cost of acquired supply could compete for capital against its existing portfolio and elbow out expectations for organic additions via the drillbit. Upon its first-quarter 2021 closing, the deal will boost Conoco’s resources with a cost of supply below $40 per barrel of West Texas Intermediate crude from 15 billion barrels of oil equivalent to 23 billion boe. It also boosts Conoco’s production profile from around 1.35 million barrels of oil equivalent per day last year to around 1.5 million boe/d, and raises it to the echelons of Exxon Mobil and Chevron in terms of US unconventional oil production. What's Next? While more consolidation is likely to follow in the US shale patch in the coming months, "not everybody is going to find a dance partner," said Abhi Rajendran, head of Energy Intelligence's Research & Advisory's (R&A's) North America Value-Chain. "It was always going to be capable companies partnering with capable buyers." The R&A unit sees fellow Permian juggernauts Pioneer Natural Resources, Parsley Energy and Diamondback Energy as others that could potentially command a small premium despite the pressure to not overpay for acquisitions. To that end, reports circulated as Energy Intelligence went to press that Pioneer was planning a bid for Parsley. (click for larger image)

Shale, M&A
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