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The Wall Street Journal: Heard on the Street: Big oil under new pressures to get bigger

Wednesday, December 20, 2006
By Russell Gold,

The oil industry is readying for a new wave of consolidation on the heels of the $30 billion deal combining Norwegian energy giants Statoil and Norsk Hydro.

The Norwegian government owns large stakes in both companies and wants to create a single national energy champion. The underlying logic of the deal — that bigger companies will better compete in the world’s increasingly crowded oil fields — also is driving the biggest publicly traded oil companies toward consolidation. These globe-spanning companies, often referred to as Big Oil, are struggling to add oil and natural-gas reserves and to increase production as they face stiffer competition and tightening access to oil and gas fields around the world. They, too, want to bulk up.

If the industry experiences a spate of mergers, the result could be less industrywide spending on oil exploration and a dimmer outlook for oilfield-service sector stocks. In other words, it would be a replay of the late 1990s, when a round of deals included the combinations of Exxon and Mobil, along with Chevron and Texaco. Capital spending on new projects languished while the companies took a few years to fully integrate.

Other factors also point to a potentially busy 2007 for energy investment banks. Wall Street is pressuring Big Oil to maintain its long string of year-over-year growth in per-share earnings. The industry’s record earnings have been due largely to rising prices of oil and natural gas, but oil prices are off since the summer and appear likely to stabilize or fall a bit further, making it harder for companies to continue delivering earnings growth.

The industry previously has responded to this kind of earnings pressure by merging companies, slashing employee head count and reducing overhead costs in order to eke out savings and pump up per-share performance.

“I think the environment is ripe for companies to be considering consolidation,” says Dan Pickering, president of oil-industry consultants and analysts Pickering Energy Partners, in Houston. “One thing these companies know how to do is consolidate and cut costs.”

Mr. Pickering and other industry analysts expect Big Oil to lead the way again. Buyers could include Exxon Mobil, Royal Dutch Shell and Chevron. The smallest of the three, Chevron, has a market capitalization of $160 billion. All three are in good financial position to make a purchase: They have low debt and vaults of cash. Share buybacks have filled their coffers with stock to use in any purchases. Analysts expect the companies to focus on North America for acquisitions.

Asian-Pacific Rim governments are unlikely to let homegrown companies be acquired. Australia, for instance, blocked an attempt in 2001 by Royal Dutch Shell to buy Woodside Petroleum. Thailand’s PTT isn’t considered in play because the Bangkok government would likely nix any deal. A handful of midsize European companies are attractive but are regarded as too pricey for a decent return.

Despite being picked over for years, North America is viewed as an attractive place for energy investment. It is one of the globe’s few oil-producing regions with a stable political environment and a favorable tax regime. Moreover, the big oil companies are getting locked out of other regions and face increasingly stringent fiscal terms elsewhere.

Most oil-and-gas fields in North America are too small to interest the biggest companies. There are three exceptions: the deep, relatively unexplored waters of the Gulf of Mexico; Canada’s vast oil-sands deposits in the western province of Alberta; and unconventional onshore gas fields, such as the Barnett Shale near Fort Worth, Texas.

Majors such as Chevron, BP and Shell dominate the Gulf of Mexico but could be interested in adding to their positions. Both Statoil and Norsk Hydro have been acquiring prospective fields in the Gulf of Mexico recently, underlining the popularity of the region. Hess’s sizable footprint in the gulf makes it a target, say analysts, but with a $13.9 billion market capitalization, it could be too small for one of the giants to bother with.

Unconventional gas operations, such as gas from tight rock formations and shale formations, also are drawing attention. In the past few years, extensive drilling and technological advances have made the industry realize many of these fields are vastly bigger than originally believed, and these fields now are attracting the likes of Exxon, Shell and other big oil companies. These fields also offer opportunities to add reserves and expand production quickly, while other hydrocarbon development prospects often take a decade of work before production begins.

There already has been one large-scale unconventional gas deal: ConocoPhillips’s $35 billion acquisition of Burlington Resources Inc. in April. “I expect another, similar deal,” says Peter Dea, former president and chief executive of Western Gas Resources Inc., which was acquired this year by Anadarko Petroleum. “If I were a major, I would be looking at companies … that have a significant position in unconventional gas,” he says.

One prospect, he says, is Devon Energy. Devon, Oklahoma City, is the largest gas producer in the prolific Barnett Shale — the pre-eminent unconventional gas field — and has very attractive deep-water Gulf of Mexico prospects. Other companies with substantial unconventional gas holdings that are being discussed as potential targets include EnCana, the Calgary, Alberta, company that has a $38.5 billion market cap, and XTO Energy, Fort Worth, with its $18 billion market cap.

ConocoPhillips is mentioned as both a target and an acquirer. In the past few years, Chief Executive Officer James J. Mulva has strung together a series of deals that catapulted a second-tier company into the Big Oil fraternity. Still, with a market capitalization of $121.6 billion, plus about $27 billion in debt, it isn’t too big to be swallowed up itself.

Big Oil is keenly interested in northern Alberta’s oil sands — a region of enormous oil deposits so thick they require extraordinary technology and expenditure to convert into fuel. The majors, except BP, already are quite active there, lured by the opportunity for sizable returns. Suncor Energy is seen as a potential acquisition target, says Tom Ebbern, executive managing director of Calgary investment adviser Tristone Capital. Suncor, Calgary, with a $36.5 billion market cap, has very large oil-sands operations, plus refineries in Canada and the U.S. A smaller potential target, Mr. Ebbern says, is Nexen. The Calgary company has a $14 billion market cap.

One final factor driving consolidation is mounting pressure in Congress for companies to do something with all their cash. “The major oil companies have a lot of excess cash. They have returned that to the shareholders through dividends and share buybacks, but they still have excess cash. The organic growth opportunities around the world are becoming fewer and more competitive,” says Clare S. Farley, chief executive of energy mergers adviser Randall & Dewey Partners LP, part of Jefferies Group Inc. “So in order to reinvest shareholder money effectively, they will look to buy other companies.” and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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