Upstream merger and acquisition activity in the Permian Basin and in the oil business overall reached record heights in 2023, and that frenzy of activity extended as well to the oilfield services sector (OFS). In the first half of 2024 hardly a day passes without at least one announcement of a deal totaling tens of billions or at least hundreds of millions of dollars.
Several factors are pushing this activity, and M&A between producers and OFS companies may actually be connected. What are the biggest factors behind this trend, what does the buying up of smaller companies portend to future startups—and how long can the buying frenzy continue? In this report those questions are discussed by Basin investor Grant Swartzwelder; Bruce On, partner, Strategy and Transactions at Ernst & Young LLP (EY); and Water Tower Research’s Managing Director / Natural Resources, Jeffrey Robertson. We will address upstream first, then make the OFS connections.
Why Buy?
Grant Swartzwelder
Shortages of drilling prospects and capital funding are among the top reasons for upstream mergers, say Swartzwelder and On. FOMO is one. “There’s such a fear of missing out,” said Swartzwelder, “and of not having the best drilling locations. So you’re seeing these larger companies wanting to gain critical mass.”
Also, On noted that many companies EY works with are looking more for current production than just future drilling prospects. “That makes it unique, that they’re not only acquiring that kind of cash flow stream into the immediate future, but they also have quite a long tail in terms of opportunities for additional development, exploration, and reserves.”
He feels that the buyer’s ability to get immediate cash flow that adds naturally to their cash flow “helps tell their story” to investors, especially when it’s combined with a disciplined approach to drilling that creates “a great story on a return to investors that [investors] really appreciate.”
On also pointed out that prime undrilled acreage is on the wane, being “mowed down like a forest,” and that this is therefore a precious commodity.
Water Tower Research’s Robertson noted that cost savings and expectations of boosting cash distributions to investors are also part of the mix. He referred to a ConocoPhillips press release about that company’s purchase of Marathon where the buyer discussed “increasing their dividend, increasing their [stock] buybacks.”
Indeed, the release quotes ConocoPhillips Chairman and CEO Ryan Lance as saying, “We plan to raise our ordinary dividend by 34 percent in the fourth quarter and we will continue to target top-quartile dividend growth relative to the S&P 500 going forward. Additionally, we intend to prioritize share repurchases following the close of the transaction, with a plan to retire the equivalent amount of newly issued equity in the transaction in two to three years at recent commodity prices.” The new entity may also sell off some non-core assets in the process, Robertson said.
Why Sell?
In one sense, there have always been E&P startups whose main purpose was to aggregate acreage and production, then sell at a profit to a larger operator. Many times the same group would then start over
Bruce On
and sell again—several times. As a specific example, Robertson noted that late May saw rumors about Double Eagle IV’s partners Cody Campbell and John Sellers expecting to offer their fourth iteration to the market later in 2024. “That’s been a very lucrative business model for them.”
For others the reason can be to reduce costs and increase payouts to shareholders, similar to the buyers’ motivation, he said.
But many of today’s sales and mergers are more out of necessity than by plan, Swartzwelder believes, because ESG concerns are drying up the sources of financing by banks and private equity (PE) providers alike.
Big is Beautiful—Most of the Time
Size is important, said Swartzwelder, because today’s producers, especially in the Permian Basin, face challenges that involve massive capital expenditures. “Many of these companies are having to create their own electrical grid system, creating their own water transportation network, so size matters.” ESG expenses, including the need for massively expensive methane capture systems to meet upcoming emissions regulations, may be too much for smaller companies to afford, he mused.
There is an irony in the bigger-is-better formula, as Robertson sees some of the M&A activity resulting in asset rationalization over the next two years. In that scenario non-core assets are spun off to smaller investors—meaning there is still room for smaller players. In fact, with all the big players getting bigger, independent investors are having trouble finding small and mid cap companies to invest in, “So I think there’s still an appetite for oil and gas companies in investor portfolios, but the choices are getting fewer.”
When the assets are spun off, Robertson said the management teams who have previously built and sold may be looking for new challenges and be ready to buy, with some investor help. “New companies will probably ultimately get created,” he said, adding, “Good management teams seem to find a way to land on their feet, if they leave a company as a result of a transaction.”
Too Much, Too Little, Too Late
Because these transactions must undergo antitrust scrutiny by the Federal Trade Commission (FTC), On notes that the growing amount of activity could create a backlog for FTC reviewers. “There’s only so much that the FTC can get through in a certain amount of time,” he said, although he and Swartzwelder agree that a global market with entire nations in the fray is hardly in danger of being dominated by any U.S.-based merger. That’s because, said On, “they’re still going to be a very, very small percentage of the global supply or demand value chain.”
Swartzwelder added that, despite congressional calls for scrutiny, some federal agencies are actually in favor of mergers. Regulators like the EPA “would prefer to have fewer companies to regulate, because they can exert more influence on those companies, and they’re easier to regulate,” and some in the Biden administration have been known to echo that statement.
How Long Can This Continue?
With each day’s sunrise there seems to sprout up a new story—or rumor, in the case of Double Eagle IV—of a sale or merger, in upstream, midstream, or OFS. Is there an end in sight?
Robertson says, “There are still a lot of people out there looking for assets,” but the trend has gone longer than some expected. Some might think, he mused, “with interest rates remaining high and oil prices bouncing around $80 a barrel, that weak gas prices might slow things down, but I think people are still looking for scale, to add production, add reserves, and eliminate costs.”
“It’s a cycle the perpetuates itself over time,” he observed. The maturity of many of the shale plays is part of the impetus. Aligning with On’s point about limited assets, Robertson said some purchasers are replenishing asset bases.
Do Not Despise the Day of Small Beginnings
OFS is also part of the merger mix, and the days of small startups may be in jeopardy. The two most recent issues of the Permian Basin Oil and Gas Magazine have featured “one-guy-and-a-truck” OFS startups that now employ dozens of people and have moved into a second generation of family ownership. Do today’s expanding giants in OFS and E&Ps mean humble startups are a thing of the past? Swartzwelder himself has started 10 companies in his career and says, for him, those days are indeed likely over.
“I’m not looking to start anything else up,” he said. “That’s partly because the company I’m in now has a lot of running room and a lot of opportunity.” But also, “I’ve seen the dynamics change so significantly that what I did 15 years ago I could not do now. Or, if I did, it would be a lot more expensive, a lot harder, and I think with less chance of success.”
As E&Ps get bigger, they’ll want to work with OFS companies that are also large enough to provide service quickly in all locations. Operators do not want to dig through a list of location-specific small companies or contend with a long list of master service agreements (MSAs), Swartzwelder observed.
How long with the rush hour on the M&A fast lane continue? As with most business and traffic trends, M&A moves in cycles, and some see things cooling off, before long—with the mergers then spinning off less-desirable assets in that process—which could create a new round of companies available for purchase.
Paul Wiseman is a freelance writer in the oil and gas industry.