Merging Forces: Is the wave of consolidation in shale over?

Nitin Kumar
Nitin Kumar Senior U.S. Energy Equity Research Analyst
December 21, 2023

The U.S. oil and gas industry has experienced a shakeup in recent months. A period of rapid consolidation, marked by a flurry of mergers and acquisitions, was headlined by two of the largest deals within the industry in recent memory. At the 2023 Mizuho Power, Energy, and Infrastructure Conference in December, featuring around 20 U.S. Oil & Gas company senior executives, there was a growing acceptance of M&A within the sector to achieve economies of scale, increase reserve depth, and gain/maintain market relevance.

Along that theme, industry giant ExxonMobil agreed to acquire Pioneer Natural Resources in early October for $60 billion in an all-stock transaction. The proposed merger would make Exxon the largest operator in the Permian Basin – an area spanning parts of Texas and New Mexico that is the highest producing oil field in the U.S. 

Later in the month, Chevron followed suit, striking a deal to acquire Hess in a $53 billion acquisition which would provide the company with access to reserves in Guyana. The Guyana discovery – one of the largest and most significant of the last decade due to the global industry’s low exploration activity – has been described as the crown jewel of current offshore reserves.

Critically, Exxon and Chevron’s recent merger activity hasn’t been driven by a focus on volume growth, but on long-term value creation through economies of scale and longer inventory life. This trend isn’t limited to industry giants. Upstream operators such as Diamondback Energy, Permian Resources, and Ovintiv have also made acquisitions in recent months to expand their North American footprint and shale inventory while moderating growth spending. 

On the other hand, there seems to be an exodus of private capital from shale, with private equity firms increasingly taking steps to sell their assets in the Permian to public players. There are very few packages of notable scale left in private hands after the M&A activity seen in 2023.

This period of rapid consolidation raises important questions: why are these acquisitions happening now? What are the major players in the space seeking to gain from these deals, and what do they mean for the future of the industry and the broader energy transition?

Why Now?

On the surface, Exxon’s and Chevron’s proposed acquisitions appear to be vastly different in their targeted reserves and geographic location. Exxon’s acquisition in the Permian Basin would bolster its short-cycle reserves and significantly improve its access to U.S. shale. In contrast, Chevron would acquire offshore, long-cycle reserves in a non-operated position in Guyana (Exxon is the operator).

But in our opinion, the motivations behind the deals are very similar. It is the mismatch between anticipated oil supply and demand globally over the long-term, and the need for scale to attract investors, that has provided incentives for these companies to act now. 

Despite prospects for a weaker macroeconomic outlook in 2024, the Organization of Petroleum Exporting Countries (OPEC) on the sidelines, and Saudi Arabia and Russia enacting voluntary cuts, the oil market remains relatively stable with a price floor well in excess of the current cash flow break-evens for the industry. 

In our opinion, although the prospects for oil demand are weak in the near-term, they will remain resilient in the long-term once economic growth resumes across the globe. Investments needed for energy transition and decarbonization goals are also likely to lead to higher oil and gas demand, at least for the next 5-10 years, if not longer.

Meanwhile, global oil exploration has been limited since 2018 and there are few near-term reserves coming to the market to bridge the supply demand gap – creating a situation where many companies will be pressed to find exploitable resources to meet demand in the years ahead.

The current economic environment is also defined by higher interest rates, which limit long cycle investments as the cost of capital increases. This means that companies with strong balance sheets and large cash reserves are better able to navigate any future rate hikes or capital supply shocks. With major players such as Exxon and Chevron maintaining stock prices near all-time highs, it’s no surprise they chose to consolidate before a more turbulent period in the market.

Shale 3.0 Business Model Emphasizes Economies of Scale

Exxon’s and Chevron’s deals highlight another principle that is becoming increasingly important for companies and investors – scale matters for both major players and smaller energy firms.

The US oil and gas industry continues to remain capital disciplined and focused on cash generation (and cash returns) – an approach known as ‘Shale 3.0.’ This not only limits long-term supply growth, but also increases the emphasis on economies of scale to increase cash margins. Investors are also focused on the longevity and sustainability of cash returns, which require a deeper and more diverse asset base. 

Currently, independent shale producers have three choices when attempting to compete in the capital markets: relying on their current business model with exaggerated cash returns and low leverage, selling out to a larger firm, or acquiring a smaller or similar sized company to increase scale. Although every firm must make a decision based on their specific needs, companies are now forced to show investors that they have the reserve depth to compete with major players in the space or be attractive enough to be acquired down the road.

This climate of fierce competition will add scrutiny to existing firms, and lead investors to ask critical questions of smaller players: do they have a problem with their assets? How much inventory do they have? How long can it last, and can they manage inventory in order to become an acquisition target in 2-5 years? This mindset – which prioritizes investor returns – will drive the next phase of M&A deals.

Looking to the Future 

While creating economies of scale is key to positioning firms for the future, executives are also keeping an eye on clean energy in their acquisition strategy. Increasingly, major players are choosing to invest in biofuels, renewable diesel, and sustainable aviation fuels, while focusing on assets that are going to position their downstream (refining and chemicals) lower on the carbon intensity curve. 

Chevron’s and Exxon’s recent acquisition targets of Hess and Pioneer demonstrate this principle is top of mind for executives. Although both deals contained few green energy add-ons, the Permian Basin and Guyana’s offshore sites are two of the lowest carbon intensity oil fields in the world. 

Going forward, major energy players will continue to research and invest in emerging green energy technology to ensure low emissions and compliance with growing regulatory scrutiny. Hydrogen power is one example. Firms are now developing innovative solutions to convert traditional materials – such as carbon dioxide, water, and natural gas – into clean energy sources like blue and green hydrogen. Carbon capture is also emerging as a key piece of the overall puzzle to lower global carbon emissions while maintaining energy availability and energy security. 

Exxon’s acquisition of Denbury, which took place in early November, was notable for its lack of emphasis on oil and gas assets and focus on carbon capture technology. Instead of acquiring traditional energy reserves, Exxon’s deal allowed them to access Denbury’s carbon capture and sequestration infrastructure, which includes the largest carbon dioxide pipeline network in the U.S. This has helped Exxon advance its net zero goals, particularly in the Gulf Coast.

However, the costs and intricacies of rapidly scaling these new processes or energy sources require companies that can onboard the technology, people, and capital to make them possible. While the work that smaller firms do is important to their communities, it’s the larger firms that can combine the production and distribution networks that will drive the energy transition in our opinion.

With the future of the industry uncertain, energy players are balancing a number of different concerns and interests as they seek to stay competitive. Investors now demand more from firms in terms of scale, capital, and inventory, and the energy transition and potential supply shocks are leading many companies to reevaluate their position in the market. While smaller and larger firms may have different reasons for scaling, it’s clear that energy players believe that consolidating now is the best way to protect themselves from the uncertainty and instability that lies ahead.


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