A new model for M&A in US oil
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In Larry McMurtry’s great Western novel Lonesome Dove, the saloon owner Xavier Wanz is said to have moved to the eponymous town “because someone had convinced him Texas was the land of opportunity… he soon discovered otherwise.” Many investors in US oil and gas will know the feeling. The SPDR S&P Oil & Gas Exploration & Production ETF has lost 87% of its value from its peak in June 2014, and 71% since its launch in 2006.
The industry needs to change, that much is clear, and consolidation is part of the solution. Bigger is not always better. In US shale, international oil companies struggled for years to match the leaner cost structures of the independents. But done right, M&A can be effective in enabling E&Ps to cut their costs through savings in sales, general and administrative expenses, and increased bargaining power over their suppliers. Companies can also cut their cost of capital by optimising their portfolios and balance sheets to improve resilience.
This year, M&A activity among companies focused on US tight oil has slowed to a trickle, with just a handful of small asset deals agreed. Until this week, the only E&P deal of any size this year was Chevron’s US$13 billion agreement to buy Noble Energy, and there it was Noble’s gas assets, not its position onshore in the US, that was the main attraction. As always at a time of high volatility in commodity prices, it has been hard to get buyers’ and sellers’ expectations to match, and the result was that there had been very little activity.
Now there are signs that that may be changing. Brent crude has been reasonably stable at around $40-$45 a barrel since late June, notwithstanding an increase in turbulence last week, and that period of calm has gone on long enough for some boards to decide that they are ready to agree deal terms. Last Monday, Devon Energy and WPX Energy announced an all-stock “merger of equals” that points the way to further consolidation in the industry.
The typical model for E&P deals in recent years has been for larger companies to buy smaller ones, to add assets for growth, often paying large premiums justified by promises of improved operational performance. Occidental Petroleum’s acquisition of Anadarko Petroleum in 2019, and Concho Resources’ purchase of RSP Permian and Diamondback Energy’s deal for Energen, both in 2018, all fit that model. Investors have generally responded unfavourably to those deals. Since the start of 2018, Occidental’s shares have underperformed the S&P E&P sector index, while Concho and Diamondback have traded roughly in line with it.
Devon and WPX are trying a different model. The deal is a merger of two businesses of a similar size, with a very small takeover premium of about 2%, and a focus on cost reduction and balance sheet strength rather than production growth. The key benefits cited by Devon in its announcement were increasing cash flow, maintaining balance sheet strength, diversifying its portfolio for greater resilience, and driving cost synergies. The presentation explaining the deal listed the priorities for the merged company as protecting its financial strength, funding the fixed quarterly dividend, maintaining base production, and generating free cash flow.
The initial response from investors has been positive. Since last Friday, Devon’s shares are up 3% and WPX’s are up 5%, in a week when the E&P sector as a whole has fallen. If the supportive response lasts, and if the merged company can deliver on its promises, it will show a route to further consolidation of the sector through similar deals. As Wood Mackenzie’s Anuj Goyal and Alex Beeker put it: “The old model of reloading quality inventory to grow faster than peers is on its way out… This opens the door for all sorts of new deal options, which could involve mergers of two large tight oil players.”
Octopus Energy plans rapid growth in the US
There was another deal in Texas announced this week that was much smaller, but similarly points to a potentially radical change for its industry. Octopus Energy, the UK retail electricity startup, made its first move into the US with the $5 million acquisition of Evolve Energy, which supplies customers in Texas.
Octopus and Evolve have similar businesses, offering customers rates based on wholesale energy prices. It is a model that can be particularly attractive as the grid takes an increasing quantity of wind and solar power, driving electricity prices down to low or even negative levels at times when generation is high.
Having taken a foothold by buying Evolve, Octopus has plans to grow rapidly in the US, and has a target of 25 million US accounts on its platform by 2027. Texas is a natural place to start: it has a competitive electricity market, a share of renewable energy on the grid that is growing rapidly, and wholesale prices that peak at very high levels when demand is high. Evolve is already offering demand response services, working with customers’ smart thermostats and other internet-enabled devices to curb consumption when prices are high and shift it to times when they are low.
“If you have a bunch of customers with storage and EVs this can be an opportunity for Texas customers to make money in the future,” says Elta Kolo, content lead for Wood Mackenzie’s grid edge team. “The use of sophisticated technology can help optimise demand and react to the market in order to take advantage of these opportunities when they come up.” The Evolve business is only small today, but if it achieves Octopus’s aspirations for growth it could play a significant role in enabling US grids to manage higher shares of variable renewable generation.
Octopus, which is 20% owned by Origin Energy of Australia, claims to be the UK’s fastest-growing private company. Launched just four years ago, it now has 1.7 million customers of its own and a total of 17 million accounts contracted to its platform, including license partners. It is aiming to have 100 million accounts worldwide by 2027.
Shell and Total accelerate transition strategies
Royal Dutch Shell plans to cut 7,000-9,000 jobs by the end of 2022, including about 1,500 people who have already agreed to take voluntary redundancy this year. The company said it expected reduced operational complexity, along with other measures, to deliver cost savings of $2-$2.5 billion a year by 2022.
In an interview on the company’s website, chief executive Ben van Beurden said it was “very painful to know that you will end up saying goodbye to quite a few good people”. He added: “We are doing this because we have to, because it is the right thing to do for the future of the company. We have to be a simpler, more streamlined, more competitive organisation that is more nimble and able to respond to customers.”
He concluded: “We have set ourselves the aim of being a net-zero emissions energy business by 2050. If we want to get there, if we want to succeed as an integral part of a society heading towards net-zero emissions, now is the time to accelerate. That is what we are doing.”
Total, meanwhile, held its investor days setting out its strategy and view of the energy outlook, and similarly talked about accelerating its progress towards net zero emissions by 2050. The summary of its plan was “increasing energy in gases, and electrons, and privileging value over volume in oil”.
Patrick Pouyanné, chief executive, said the surge in demand for clean energy and support from government and investors meant that the time was right to accelerate the company’s shift into low-carbon technologies. “Our oil and gas businesses will fund the transition, even at $40 a barrel, for profitable growth in renewables and electricity while supporting the dividend at the same time,” he said. He added that the 2020s would be “a transformative decade” for Total.
The first presidential debate between Donald Trump and Joe Biden was widely criticised for generating more heat than light shed on the two men’s policy agendas. However, it was somewhat more relevant to the energy industry than expected, with a question on climate change that was not on the originally published agenda. The answers showed how both candidates have been seeking to shift their positions towards the centre-ground. Biden disavowed “what he [Trump] calls the 'radical Green New Deal’,” emphasising that his own clean energy plan was different, while Trump talked about planting trees and said, “I’m all for electric cars”.
If Joe Biden does win the election and seeks to implement the “clean energy revolution” he has promised, he should avoid trying to bring it about through executive orders, and should instead work with Congress to pass bipartisan legislation, Senator Sheldon Whitehouse warned. The senator, a Democrat from Rhode Island, told the Greentech Media Power and Renewables Summit: “If you go down a regulatory path, that path likely ends up in litigation, and that litigation likely ends up in the Supreme Court. And there are very powerful interests at work in the US to make sure that the Supreme Court is very polluter-friendly.”
Global energy storage capacity is expected to grow at an average rate of 30% a year out to 2030.
The Federal Energy Regulatory Commission held a day-long conference on carbon pricing in wholesale electricity markets. The general view of participants, reported the Niskanen Center’s Nader Sobhani, was that “carbon pricing is the most cost-effective, transparent, and market-friendly way for electricity markets to reduce their carbon footprint.”
US energy-related carbon dioxide emissions fell by 2.8% last year, mostly because of a decline in coal-fired power generation. The shift from coal to gas was the single most important factor, but the rise of renewable energy has also been significant.
The wildfires in California last month created so much smoke that they cut solar power output in the state.
Elon Musk has said he feels “a bit bad about hating on the oil and gas industry”. In the Sway podcast from the New York Times, he said: “For a lot of the people in the oil and gas industry, especially if they’re on the older side, they built their companies and did their work before it was clear that this [climate change] was a serious issue,”
And finally, some more music. After Justin Bieber’s take on the oil industry downturn last week, this time it is hip-hop group Public Enemy with some energy-related output. Their new album, 35 years into their career, is titled What You Gonna Do When The Grid Goes Down? A blackout, leader Chuck D suggests, could be a good thing: “No internet, no text and no tweets… No apps, just maybe perhaps, no grid is what we need for new human contact.”
Quote of the week
“We firmly believe in this approach and from our listening we have realised there is a very significant need to change bp. And I think – if anything – the share price performance of the sector is a robust case for change in itself.” — Bernard Looney, chief executive of BP, responded to a critical comment on LinkedIn with a defence of his plans to change the company.
Chart of the week
This comes from Wood Mackenzie’s new Energy Transition Outlook, which I summarised in a recent article. It shows two trajectories for future greenhouse gas emissions: in darker green, Wood Mackenzie’s base case forecast, and in paler green, a course that would be consistent with the Paris climate agreement goal of limiting the rise in global temperatures to “well below” 2°C. You can see there is a very wide divergence between them. The path we are on leads to global emissions hitting a plateau around 2030, and declining only slowly thereafter. The Paris-compliant scenario needs a peak in the mid-2020s, and a rapid decline thereafter. The 2°C scenario is not unachievable. But it will require some sharp changes to government policy, innovation and the deployment of low-carbon technologies to get there.