Exxon deal hunt indicates that there may be a boom in Shale M&A

Exxon Mobil Corp.'s XOM 0.15% search for a blockbuster deal in the U.S. shale could be the beginning of a bonanza of deals as drillers seek to put large war chests of funds to use.

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The oil giant has held preliminary talks about a possible acquisition with Pioneer Natural Resources Co., PXD -0.89% a Texas-based company with a market cap of $52 billion, according to a report last week published by Trade Algo. There have also been talks between Exxon, which has been on the prowl in the Permian Basin for months, and at least one other company, according to Trade Algo, about a potential deal.

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As a result of such a transaction, the Permian basin, one of the hottest oil fields in the U.S., would send the strongest signal yet that drillers are on the verge of expanding their operations through acquisitions. In the oil industry, there are companies that boast healthy balance sheets, which enables them to shop for targets and can afford to do so. 

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There has been no formal process between Exxon and Pioneer, and any deal, if it does occur, is probably not going to be complete before the end of this year or the beginning of next year. Exxon's stock dropped less than 1% in Monday's first trading session since Trade Algo broke the story, while Pioneer's stock rose about 6% on that same day.

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Analysts and investment bankers have said that conditions are ripe for a deal frenzy in the oil patch in the coming year due to the current market conditions. 

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After pursuing rapid growth for more than a decade, the shale industry has shifted to a mature business backed by fiscal restraints as well as hefty investor payouts as it transitions from rapid growth. However, there is a dwindling number of drilling locations available for shale companies to exploit. Many companies have found that drilling for new oil discoveries has fallen out of favor with investors in recent years, and so they have no choice but to acquire rivals in order to extend their runway. 

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“Generally speaking, I think there is more consolidation that needs to happen within our business,” ConocoPhillips Chief Executive Ryan Lance told analysts in February.

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The Wall Street community poured money into several American frackers on Monday, including APA Corp., Coterra Energy Inc., and Diamondback Energy Inc., adding $7 billion to the market value of the 20 largest independent oil-and-gas companies in the United States. Despite the decline in oil prices of about 1% on Monday, shale stocks continued to grow because investors were betting on an increase in mergers and acquisitions in the oil industry, according to Neal Dingmann, an analyst at Truist Securities. 

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As a result of a growing desire for growth, U.S. shale has experienced a mergers-and-acquisitions boom in the last decade. It has been estimated by Mizuho Securities that between 2014 and 2019, the industry will have seen a total of 407 deals a year, not necessarily M&A deals, with a total annual value averaging about $90 billion.

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Nevertheless, the pace of M&A slowed down after the pandemic gutted oil demand and hurt companies' balance sheets in the aftermath of the pandemic. In order to meet investors' demands for cash returns, drillers have also had to tighten their belts. As per Mizuho, there were, on average, 180 deals for $59 billion a year between 2020 and 2022, and that number is expected to rise in the future. 

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Now that producers have deep coffers at their disposal, they can pursue deals in a much more aggressive manner. Oil and gas companies were able to make windfall profits due to Russia's invasion of Ukraine last year, which sent global oil prices soaring to more than $127 a barrel. 

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As of the end of last year, the ten biggest publicly traded shale oil and gas companies in the United States earned more than $70 billion in profits, according to FactSet's analysis of the industry. As a result, Exxon Corporation netted $55.7 billion in profits, while Chevron Corporation raked in $35.5 billion in profits. 

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There is a good chance that the next wave of oil deals will be forged in the Permian Basin in West Texas and New Mexico, according to energy analysts and executives. Exxon and Chevron are among the companies that favor the region for its shale wells that are able to produce rapidly and do not tie the companies into decadeslong megaprojects that have fallen out of favor with some investors who fear any decline in the oil market in the future.

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In the event an oil major like Exxon or Chevron buys a big Permian company, "that could obviously spark a speculative boom," said Adam Rozencwajg, a managing partner at the investment firm Goehring & Rozencwajg.

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Over the past decade, Exxon has poured a lot of money into the Permian Basin and continues to consider the region a key source of growth, alongside its massive oil discoveries in Guyana. There was an average output of about 550,000 barrels a day in the Permian last year, and the company plans to increase production there by a million barrels a day by 2027, according to the company.

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In spite of this, as the region matures, companies have been facing issues with disappointing wells. In 2022, the average Permian well was expected to produce 5% less oil per lateral foot than the previous year, according to research firm Enverus. As a result of Enverus data analyzed by JPMorgan Chase, one of Exxon's 2022-vintage wells in the Permian Basin are 8.4% less productive than the prior year, according to Enverus data.

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Aside from less-productive wells, operators are also facing the challenge of shrinking inventories of drilling sites that are available for use. Raymond James Financial estimated last year that the best locations in the Permian will disappear in less than eight years, based on their analysis of public and private companies. 

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Moreover, the double whammy creates incentives for companies to merge to take advantage of new drilling opportunities as well as create economies of scale, according to executives and investors. 

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Inflation has also played a role in whetting producers' appetites for deals, as a result of which companies have been unable to deploy their capital effectively. Since the cost of labor, steel, and equipment has shot up in recent years, companies have found that they will have to increase their spending by about 20% from 2022 to 2023 without reaping any additional benefits. 

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The ability to snap up a competitor allows drillers to increase production while keeping costs at a minimum, said Muhammad Laghari, a senior managing director at Guggenheim Securities, a leading investment bank. 

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“Acquiring a company is probably one of the most cost-effective ways for companies to increase their cash flow per share right now, given the inflationary environment we are experiencing,” he said. 

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Despite oil-price volatility in recent months, the U.S. oil benchmark has dropped approximately $43 from its peak last June and is now in the range of $70 to $80, which provides a level playing field for negotiations between the two sides, analysts said. On an earnings call in January, Exxon CEO Darren Woods said that the company is looking for opportunities in the Permian Basin, but that it is difficult to buy at the peak of a commodity cycle at the time.

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It has been suggested that consolidation in the Permian could contribute to a slowdown in activity there since public companies-the most likely acquirers-have been more conservative with their drilling programs compared to private companies.