21 Jul Consolidation in US Shale and the Risks to Capture Value
Shale drilling over the last 20 years has turned the US into the largest oil producing nation in the world. However, the current coronavirus pandemic and the ensuing economic downturn is having a detrimental impact on shale companies, and on the Oil & Gas industry as a whole. At current crude prices, more than 200 shale companies are at risk of bankruptcy. Top performers could capture some great deals, or find themselves sinking, too.
Unsurprisingly, M&A activity in US shale was at an all-time low to start the year. Activity has ramped up over the last few months, with deal value of $2.6 billion in Q2, up from $770 million in Q1, however it is expected to remain relatively slow in the coming months (barring any significant changes to crude prices). Most of this activity was focused in Appalachia, with the largest deal being Shell’s $541 million sale of its upstream and midstream Appalachia business to National Fuel Gas. Q2 was still low compared to most quarters over the last 10 years, but it did signal the sector’s willingness to look for opportunities in an uncertain time. Activity is expected to expand to Haynesville throughout the second half of the year as shale drilling continues to grow in North America.
Company press releases rehash the same rationale for these deals (e.g. “reduced operating expenses from contiguous drilling areas”). These deals may look like a sure thing at first glance, however the challenges involved going forward with these types of deals need to be explored to understand how much of the deal value could be at risk. Well design, capital intensity, and operations experience are just a few areas that need to be addressed to get the most out of any deal.
Companies looking to find deals will need to show significant value creation potential to convince skeptical investors, given the current environment. That said, there will be opportunities for top-performing shale players to find discounts in the market. Many underperforming companies already struggling financially will find it even more challenging with the negative economic outlook. The key will be to find the good targets quickly and efficiently.
Creative alternative approaches can create value quicker than standard acquisitions by reducing risk and minimizing the capital required to complete a deal. Chevron’s joint venture with Cimarex Energy in the Permian Basin is a good example of this. Cimarex is known as one of the strongest operators in the region, with profitable operations since 2016. Not only do deals like this give companies a share of any production, but it also is an opportunity to share best practices on operations and drilling strategies. Expect this type of activity to continue and expand to other shale regions.
With significant price volatility in the shale market and global economic recession, finding the right shale opportunity at the right price will be more important than it has ever been in the last 20 years of the shale boom. Understanding the underlying risks to the value, designing the best plan to achieve that value, and knowing what other options are available will give companies the best chance to thrive.