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Houston Chronicle: Energy sector could see more mergers in ’07

Production and access challenges may drive growth
By KRISTEN HAYS

Oil exploration and production companies that have enjoyed record profits fueled by high commodity prices over the last two years may go to the altar in 2007 to keep growing.

Analysts say the energy sector could see more mergers and acquisitions to counteract difficulty in gaining access to oil and natural gas and higher costs of getting it to the surface.

Fadel Gheit, an oil analyst with Oppenheimer & Co. in New York, said many oil companies are in prime financial condition with clean balance sheets and billions on hand.

But he said the challenge to maintain production — let alone increase it — in the face of rising costs and competition for access could prompt companies seeking growth to go shopping.

“Companies either have to grow or get out of the way,” Gheit said.

This year companies largely pumped up or streamlined asset bases with multimillion-dollar deals to buy and sell portions of each other’s holdings. Such deals often involved interests in oil and gas fields in North America and the Gulf of Mexico or access to unconventional resources such as oil-soaked sands in Canada or oil shale in the United States.

Bigger deals included ConocoPhillips closing on its $35.6 billion purchase of natural gas producer Burlington Resources.

Then Anadarko Petroleum Corp. bought Kerr-McGee Corp. and Western Gas Resources for more than $21 billion to increase its North American footprint, particularly in the Rocky Mountains and the Gulf.

And earlier this month Statoil, Norway’s state-controlled oil company, announced plans to buy offshore energy and oil operations of Norsk Hydro, Norway’s largest publicly traded company. The $28 billion deal, expected to close in the third quarter of 2007, will create the world’s largest offshore operator, surpassing Royal Dutch Shell.

Reinvestment challenges

Norsk Hydro’s aluminum, hydroelectric and solar power operations will remain as a separate company.

Analysts expect more mergers in 2007, particularly with increased competition from state-owned oil companies that can make acquisitions unfettered by investor pressure for near-term increases in earnings or cash flow.

“They’re just seeing an increasingly challenging reinvestment environment,” said Dan Pickering, an analyst with Pickering Energy Partners in Houston. “Access to foreign jurisdictions is tougher, competition from national oil companies is hotter, and host governments from across the world are extracting more money to participate.”

When faced with such a playing field, and commodity prices unlikely to rise above 2006 levels, companies seeking growth tend to fall back to what has worked before: consolidating to cut costs while adding strength, Pickering said.

Simmons & Company International, a Houston-based independent investment bank, said in a recent research report that so-called organic replacement of reserves — or ability to replace reserves on their own rather than through acquisitions — was less than 100 percent in the last two years and likely to remain “relatively meager for some time to come.”

Simmons estimated that oil majors would generate $245 billion in cash flow and asset sales in 2007, and have $80 billion of that available for stock buybacks or acquisitions.

Simmons also speculated on which companies are likely acquirers or likely to be acquired.

The report said potential acquirers include Irving-based Exxon Mobil Corp., the world’s largest oil company, which can best afford an all-cash deal, “but appears to be patiently awaiting one of its large peers to be selling at a steep enough discount to make the plunge.”

The report also noted that San Ramon, Calif.-based Chevron Corp. has spare cash as well, and Houston-based Marathon Oil Corp. has said it’s seeking a Canadian oil sands partner.

Clarence Cazelot, Marathon’s CEO, said at the company’s recent annual analysts conference that acquisitions were “growth opportunities” and “are going to be part of our business.”

When asked how strongly he felt about maintaining Marathon’s independence, Cazelot reiterated his stance that any buyout offer would be evaluated to determine if it would benefit shareholders.

“We have no hard and fast position either way. We spend our time growing the business,” Cazelot said.

Seeking swaps

The Simmons report said Paris-based Total has indicated it’s looking for asset swaps rather than acquisitions, while London-based BP has said it intends to distribute excess cash and has not claimed to be seeking acquisitions.

Houston-based ConocoPhillips has said the company is satisfied with its Burlington Resources addition for the time being, while the Netherlands-based Royal Dutch Shell’s 2006 oil sands acquisitions could indicate a continued push to acquire unconventional resources, the report said.

Several companies declined comment on future merger and acquisition activity, as is routine. But Karen Matusic of the American Petroleum Institute said, “We believe market forces always lead companies to look for ways to improve their efficiency in order to compete on a global basis.”

Antitrust drawbacks

Analysts don’t rule out a combination of majors that would rival Exxon Mobil. However, antitrust issues would arise if a merger combines refining and marketing segments that could dominate refining capacity or corner a market of gas stations.

“If we look at 2007, it’s unlikely that we’ll see an integrated oil company taking over another integrated oil company if they both have a presence in the U.S. gasoline market,” said John Walker, president and CEO of EnerVest Management Partners in Houston, which manages oil and gas assets for institutional investors. “It’s unlikely that, say, a ConocoPhillips or a Shell could buy Marathon.”

But some independent companies, which focus on oil and gas exploration and production rather than refining and marketing, could be attractive potential targets if they would quickly boost earnings without antitrust worries, analysts said.

Those companies include Newfield Exploration Co., Anadarko, Noble Energy and Apache Corp., all based in Houston, as well as Oklahoma City-based Devon Energy, the Simmons report speculated.

Some could attract suitors because of diversified portfolios, although Apache’s includes assets acquired from some of the oil majors. The report noted Anadarko’s deep-water success — as well as its access to deep-water drilling rigs when other companies are struggling to secure them — could enhance its attractiveness.

But Anadarko’s continued integration of assets from the Kerr-McGee and Western Gas acquisitions as well as ongoing asset sales to reconfigure its portfolio is “likely to keep potential acquirers away in the near-term,” the report said.

Either way, Gheit said, acquisitions likely won’t come cheap because acquirers want the right fit.

“Cheap companies are cheap for a reason— either they don’t have attractive assets or they don’t fit with companies interested in buying assets,” he said. “Regardless of how much it costs me, as long as I’m confident I can employ this money in a higher earnings investment, I’m ahead of the game.”

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Dec. 30, 2006, 7:22PM
Copyright 2006 Houston Chronicle

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