Return Of Mergers And Acquisitions: Oil Sector Dealmaking Heats Up

Reports of the shine going off the oil and natural gas sector with investors have been greatly exaggerated.

Investment in oil and gas companies listed on the S&P 500 increased by more than 26% this past year, even as the index tumbled by 5% overall.

A sector left for dead during the Covid-19 pandemic – when energy demand plummeted, and crude oil prices briefly went negative – is experiencing a remarkable turnaround.

A rebound in commodity prices caused by geopolitical long-term supply disruptions and heightened balance sheet discipline has made energy the best-performing sector on the large-cap index of premier U.S. stocks.

Gone are the dire predictions that peak oil demand was reached in 2019, as forecasters like the International Energy Agency now expect consumption to hit a record high this year and to keep growing for the next 15 years and beyond.

U.S. oil and gas companies are queuing up for initial public offerings (IPO) again, the clearest sign yet that the sector, which is sitting on record amounts of cash, is back in favor with Wall Street investors.

Texas-based oil and gas producer TXO Energy Partners in January became the first energy company to go public in more than six months. Another nine energy companies have filed or updated their initial public offering documents during the past 90 days, according to Renaissance Capital.

If they all are listed this year, as expected, it will be the oil and gas sector’s strongest IPO showing in six years.

The oil and gas industry is also sitting on record amounts of free cash flow – the amount of cash a company has after deducting operating expenses and capital expenditures – thanks to a greater commitment to capital discipline and higher oil prices, prompting renewed interest in mergers and acquisitions (M&A).

The top 25 North American exploration and production (E&P) firms in the oil and gas sector were sitting on roughly $85 billion last year, according to analyses by McKinsey and Company. The same industry players ended the year with a cash balance estimated at $70 billion to $100 billion.

The sector’s commitment to cash-flow generation is expected to remain high, reaching between $70 billion and $90 billion this year and between $50 billion and $70 billion annually through 2027. That’s likely to remain true even if the U.S. benchmark West Texas Intermediate (WTI) oil price hits $65 a barrel.

A resurgence of M&A transactions is yet another sign of how hot the oil and gas sector is becoming. The rumor mill of possible strategic deals is heating up, most recently with the suggestion that Pioneer Natural Resources could be for acquisition.

The industry is sitting on hundreds of billions of dollars that will drive a new wave of strategic upstream deals as shale companies seek to replenish their inventories of prospective acreage through consolidation now that many have chewed through their best leases after years of breakneck expansion.

Rewarding shareholders with fat dividends remains a top priority for the E&P sector, which is expected to return as much as $40 billion to shareholders through share buybacks in the next year. But with debt levels dramatically reduced and oil prices expected to remain elevated, companies are looking at how to keep the good times rolling for longer. Adding more top acreage to their portfolios through upstream M&A deals makes a lot of sense right now.

Top shale producers want to consolidate their positions in the most prolific basins and leverage their operational advantages to improve efficiency and, ultimately, returns. More cautious players may add assets in adjacent portions of the value chain to expand their reserves.

Most M&A players are keeping a watchful eye on the energy transition and the political debate surrounding U.S. energy policy. They want to use their cash stockpiles to reshape their portfolios to stay ahead of the policy debate, improve their resilience to price volatility, and reduce Scope 1 and Scope 2 emissions.

The oil and gas sector has experienced significant consolidation over the years, with many large companies acquiring smaller competitors. This trend is expected to continue as companies look to streamline operations and reduce costs. Assets with low breakeven costs and even lower emission profiles are in great demand. “Low cost, low carbon” is the sector’s new M&A mantra.

The oil and gas sector has had some of the hottest-performing stocks on the market in the past two years. In 2022, oil giant ExxonMobil gained a whopping $195 billion to reach a market cap of $454 billion, while tech goliath Apple shed over $846 billion to end the year with a market cap of $2.1 trillion.

No one suggests that the oil and gas sector will overtake Big Tech. But with interest rates rising, inflation still running high, and investors increasingly looking to “income” stocks that pay fat dividends over “growth” equities, traditional energy stocks look very attractive.