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Fair weather for oil industry mergers as project costs soar

Daily Telegraph

Breakingviews.com

28 October 2008

The stars appear to be aligning for oil and gas deals. Costs are soaring as the industry moves into bigger and more complex projects.

Resource-rich nations are becoming increasingly hostile, making the quoted companies’ quest for reserves more urgent. The sharply lower oil price will make life tough for inefficient producers.

The last big round of consolidation, in the late 1990s, was triggered by a collapse in the oil price to below $15 a barrel. By that standard, prices are still high. But for producers, the pain barrier is also higher now.

Cost inflation has raised the price necessary to achieve break-even on non-traditional projects: Already, firms are starting to cut back on investment at the margins. Statoil, for example, has delayed its investment in Canadian oil sands.

Add in the steep drop in prices for quoted oil and gas companies, and M&A starts to look more attractive.

Look at BG, whose perennial takeover premium is rapidly evaporating. Its shares have fallen 40pc in the past month. Some, but not all, of BG’s drop can be justified by fundamentals, such as a deteriorating outlook for liquefied natural gas prices on weakening demand from Asia, or falling spot prices. But buyers with potential synergies could well see bargains.

Of course, for many companies financing is an issue. Banks aren’t yet willing to lend for big deals, and acquirers maybe reluctant to issue paper at what they perceive to be massive discounts to fair value – unless the target is equally mispriced.

The exception to the rule is Exxon, which was reportedly snooping around BG earlier this year. It could have enough cash to pay for BG – $44bn (£28bn) at a 30pc premium to Monday’s price – without breaking into much of a sweat, by cancelling its share buyback programme.

Oil and gas chief executives, a conservative lot, have shied away from using high energy prices to justify big deals. The collapse of the markets could spur them into action.

Fiona Maharg-Bravo

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