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Credit crisis, cheaper crude to boost oil M&A


Thu Oct 23, 2008 5:54am EDT

By Tom Bergin – Analysis


LONDON (Reuters) – The credit crisis will spur more takeovers in the oil and gas industry as cash-rich oil majors and utilities pounce on small and mid-cap companies whose shares have been hit hard as they struggle to fund developments.

Oil majors such as Exxon Mobil and Royal Dutch Shell Plc will likely use the crisis to accelerate their strategic push into North American gas production and the Canadian oil sands, bankers and analysts said.

Similarly, utilities like Germany’s RWE, France’s GDF Suez and Britain’s Centrica, which have long sought to produce more of the gas they retail, are also predicted to take advantage of lower asset prices.

“We would expect there to be more consolidation,” said Karl Nietvelt, director of oil and gas at S&P. “Prices are indeed very cheap.”

Recession fears have halved the price of oil since July, when it topped $147/barrel. The drop has hit share prices across the sector but small and mid-size oil and gas exploration and production (E&P) firms have been among the hardest hit.

This is because the E&P players are more leveraged to crude than the oil majors, which have refining, chemicals and retail units, and because, with low production levels or none at all, the E&P firms are more reliant on debt funding.

Devon Energy President John Richels said earlier this month he expected consolidation among mid-size North American E&P players, typically worth between $5 billion and $20 billion, which have expanded rapidly in recent years.

Thierry Bros, analyst at Societe Generale in Paris, said the majors may snap up such firms or their assets to help address their own failure in recent years to grow their reserve bases.

“Some of the independent companies are facing trouble. It’s going to be a good way for the majors to get resources in a non-OPEC country,” Bros said.


Bros thinks the majors will be especially keen to use their strong cashflows and low debt levels to expand in “unconventional” gas plays, such as tight gas, coal bed methane and shale gas – which are more plentiful than traditional gas opportunities but more difficult and expensive to exploit.

Chesapeake Energy, which holds vast unconventional gas resources, said it would sell up to $3 billion in assets in the fourth quarter to fund developments after shares in the highly leveraged company slumped on funding fears.

British oil giant BP Plc is expected to be among potential bidders after agreeing last month to buy a minority stake in some of Chesapeake’s shale assets for $1.9 billion.

The majors could take advantage of similar weakness among the smaller players in Canada’s oil sands industry, where companies squeeze crude from bitumen-soaked soil, Nick White, head of the energy practice at consultants Arthur D Little said.

A surge of interest in oil sands in recent years lifted asset prices and operating costs to levels that deterred some oil majors such as Italy’s Eni from investing.

But the oil price fall has hit shares in smaller players like UTS Energy hard, amid fears they may not be able to finance projects.


European gas utilities may also use the current financial crisis, and their own low debt levels, as an opportunity to reduce their exposure to gas prices by buying upstream assets. High prices had made this strategy difficult to execute in recent years.

“The utilities have a great appetite for the right assets in the right location, which tends to be in Europe, North Africa, some parts of Russia and the Middle East,” White said.

One banker said that European utilities would buy gas or oil assets because the price they pay for gas is usually tied to oil prices, so either energy source hedges their input costs.

Europe’s smallcap oil sector, which is centred around the London Stock Exchange’s junior AIM market, is likely to see a rash of forced sales, said Andrew Moorfield, Head of Lloyds TSB Corporate Markets’ oil and gas team.

While these companies’ assets are generally too small to be of interest to the majors, they could fit the utilities’ needs.

Mergers at the top tier of the oil industry, among companies such as Exxon, Shell, BP, Chevron and France’s Total, remain likely to be blocked by regulators, oil executives say, but deals below this level may now be more likely.

In recent years, BP, Shell and Exxon repeatedly said high valuations, on the back of record crude prices, meant they saw little value in takeovers in the $20 billion and over range.

But the DJ Stoxx Oil and Gas Titans index of industry leaders has almost halved since May.

Earlier this week, analysts at JP Morgan Cazenove said British gas producer BG Group, which has a market capitalization of $42 billion could be a target after a 47 percent fall in its shares since May.

“Exxon Mobil could have net cash in excess of BG Group’s market enterprise value by year-end 2009 if it were to suspend its share buyback program in 2009,” the brokerage said in a research note.

(Editing by Chris Wickham)


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