Royal Dutch Shell Plc .com: Anadarko deal heralds beginning of the end

FROM THE FINANCIAL TIMES
By Carola Hoyos in London

Published: June 26 2006 03:00 | Last updated: June 26 2006 03:00

Anadarko Petroleum has taken a big bet that oil and gas prices are going to stay at their record highs with the acquisition last week of Kerr-McGee, a smaller rival.

In so doing the fifth-largest US oil and gas company contributed a brush stroke to the changing landscape of the mid-sized US energy industry.

If 1998 marked the birth of the super major as Exxon merged with Mobil, BP with Amoco and Total with PetroFina, then the past 12 months appear to haveheralded the beginning of the end of the US mid-tier oil companies.

“Of the mid-tier US companies, on a two to five-year time scale, are any of these guys going to be left?” said Derek Butter, analyst at Wood Mackenzie, the Edinburgh consultants. He added Marathon, Amerada Hess and Devon were most likely to be the next targets.

Anadarko – which has long been eyed by companies such as Royal Dutch Shell, the AngloDutch group, for its gas assets – has perhaps made itself an even more attractive target with last week’s deal.

Mergers and acquisitions in the oil sector began to boom again last year, after years of executives arguing that prices were too high. In 2005, worldwide mergers and acquisitions more than doubled to $160bn – the highest level since 1998.

Anadarko’s $16.4bn deal is the third big acquisition among the mid-sized US energy companies since last summer. In the second half of last year ConocoPhillips bought Burlington Resources for $36bn and Chevron beat the Chinese in the $20bn battle for Unocal. On a smaller scale, Occidental Petroleum took Vintage for a little more than $4bn that year as well. Meanwhile, across the US’s northern border, Total, of France, bought Canada’s Deer Creek for $1.3bn.

A study by Harrison Lovegrove, the UK-based corporate advisers, and John S Herold, the US research firm, found that executives were willing to pay 54 per cent more in North America, betting that high oil and gas prices were here to stay.

Part of the reason is desperation and a wad of cash. Big oil companies have had trouble finding new oil and gas reserves through exploration because many of the world’s remaining reserves lie in countries unwilling to open them to foreign investment. In the meantime, however, the $70 oil price has swelled war chests. ExxonMobil, the world’s biggest energy group, has $30bn-$40bn at its disposal.

But Exxon and the world’s other huge international oil companies are unable to use that money to buy each other because of regulatory hurdles. Mid-size energy groups without large numbers of petrol stations, pipelines and refineries, often the cause of regulatory scrutiny, are easier targets. Size has made companies such as Devon and Anadarko vulnerable: they are too big for modest drilling success to deliver good growth results, but too small to compete with huge national oil companies or to venture into challenging new terrain.

But buying a mid-tier company does not solve some of the most serious challenges that energy companies face. Shortages of equipment, especially drilling rigs, and labour, particularly engineers, have helped push companies’ capital expenditure up 66 per cent since 2002 even though the money is going to producing 30 per cent fewer barrels, analysts at Deutsche Bank calculate.

This new reality is showing up in share prices. Oil prices have jumped from $55 to $68 a barrel in the past year, but the share price of Exxon has not budged from $57. “Returns are under steep pressure as taxes and costs spiral higher, and competition in the remaining non-governmental opportunities eats away at remaining returns,” Deutsche Bank said in a recent report.

As the cost of the US mid-tier companies rises with each acquisition, the next company to buy one will be placing an even bigger, bolder bet than Anadarko.

Copyright The Financial Times Limited 2006

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