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Oil price sets stage for mergers: “We expect a lot of mergers and acquisitions in the next 12 months,” says Fadel Gheit


Thursday, December 04, 2008

OTTAWA — It’s getting to be cheaper to drill for oil in industry boardrooms than in the world’s far-flung oil fields.

With crude prices slumping dramatically, oil companies have seen their share prices hit bargain-basement levels, providing a tempting target for cash-rich predators that are eager to boost their reserves.

“We expect a lot of mergers and acquisitions in the next 12 months,” Fadel Gheit, analyst with New York-based Oppenheimer & Co. Inc., said in an interview. “Historically, after every oil-price cycle, within six to 12 months we end up with major industry consolidation.”

Crude prices continued their four-month plummet yesterday, dropping more than 7 per cent – or $3.12 (U.S.) a barrel to $43.67 on the New York Mercantile Exchange. Many forecasters believe oil prices could fall further still – perhaps as low as $30 a barrel – as demand falls in the face of a slumping global economy.

Falling prices – combined with stubbornly high costs – have led several companies to cancel or postpone both production and upgrading projects in Alberta’s oil sands. Norway’sStatoilHydro ASA became the latest to do so, announcing yesterday that it would not proceed with a proposed $4-billion (Canadian) upgrader, citing “prohibitive construction costs.”

Mr. Gheit said the industry is suffering a serious hangover from the boom times of just four months ago, and will need a major consolidation to adjust to the lower price environment, which could last for several years, depending on the depths and duration of the global recession.

The last major price slump, in 1998, set the stage for mergers between Exxon and Mobil Oil, and BP and Amoco Petroleum, he noted.

After five years of rising prices that peaked at $147 (U.S.) a barrel this summer, the world’s largest oil companies – including Exxon Mobil Corp., Royal Dutch Shell PLC, BP PLC, and Chevron Corp. – remain flush with cash.

That group of so-called “supermajors” is estimated to have a collective war chest of $200-billion.

At the same time, those giants have found it costly to add to their reserves, as producing countries increasingly declare their oil fields off-limits to international oil companies.

As a result, the majors have increasingly focused on unconventional areas like the oil sands or offshore in the deep waters of the Gulf of Mexico and Atlantic Ocean.

In a recent research report, Credit Suisse energy analyst Mark Flannery noted that the major international companies – which control just 10 per cent of the world’s reserves – face serious challenges in replacing those reserves or adding to them.

“Big Oil has a growth problem for sure but is extremely well capitalized and we now see an M&A window opening,” Mr. Flannery wrote.

Though oil sands production is high cost, the sector remains attractive to major international companies because of the long life span of the reserves, and the relative absence of political and exploration risk, said Martin Molyneaux, analyst at FirstEnergy Capital Corp. in Calgary.

In the United States, independent producers, including Anadarko Petroleum Corp. (down more than 50 per cent this year), Devon Energy Corp. (down 25 per cent), and Marathon Oil Corp. (off 65 per cent), are all considered targets for the supermajors.

In Canada, “everybody is for sale,” Mr. Molyneaux said.

He said companies are now doing end-of-year engineering work that will detail their 2008 costs in adding new reserves. That information will allow them to determine whether it is cheaper to buy or drill, and would indicate to potential acquirers how a company stacks up in a key stock-market metric, the per-share cost of adding reserves.

Companies could also decide to launch aggressive share-buyback schemes, hoping to boost their stock price by spreading their current reserve base over a smaller pool of shares.

© The Globe and Mail


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