Market Insider

Chevron deal for Anadarko seen kicking off new merger fever in US oil patch

Key Points
  • Chevron may have just unleashed a new wave of deals in the oil patch with its $33 billion acquisition of Anadarko.
  • Shares of other independent exploration and production companies jumped as investors speculate on other targets, driving up valuations for a sector that has lagged the market.
  • "I do think this will start a land rush of deals," Again Capital's John Kilduff says.
A worker prepares to lift drills by pulley to the main floor of a drilling rig in the Permian basin.
Brittany Sowacke | Bloomberg | Getty Images

Chevron's $33 billion acquisition of Anadarko could set off a wave of new merger activity in the oil patch as the major companies seek out a bigger foothold and lower costs in the U.S. shale sector.

Stocks of prospective targets surged after the deal was announced Friday. The speculation centered on major Permian shale players, like Pioneer Natural Resources, Parsley, and Concho Resources, all up about 10%. Others were also higher, including Apache and Hess, with a big position in North Dakota's Bakken basin.

Occidental Petroleum, was initially higher but reversed gains after CNBC's David Faber reported that it had made an earlier failed bid for Anadarko, and it is now considering options.

The Chevron deal, valued at a total of about $48 billion with debt, pushes energy sector merger activity to about $200 billion for the year, its highest level ever, according to Refinitiv.

"You have more than 100 producers in the Permian. The E&Ps have gotten better about turning cash flow positive but the big guys, Exxon, Chevron and Oxy [Occidental] are planning to get bigger. They're all planning to expand in U.S. shale. even though they all have longer term projects," said Stewart Glickman, energy analyst at CFRA. "Exxon and Chevron had deep water. They have [liquified natural gas], but they are still pushing more in the direction of shorter cycle projects, and that means U.S. shale."

Anadarko stock rose 31% after Chevron offered $60.95 per share in stock and cash. The deal gives the second biggest U.S. energy company a boost in shale oil production as well as natural gas and offshore deep-water.

RBC analyst Scott Hanold said the move by Chevron changes the deal landscape. While there were a half dozen significant deals in the sector last year, they were E&P companies buying rivals in mostly stock deals.

"Different from last year, this transaction could also 'kick-start' investor interest in E&P's with current valuations looking attractive, [free cash flow] generation that is growing, oil prices that are well above most budgets while service costs remain benign, and now possible interest by the Majors making the prospect for larger premiums and a cash component," Hanold wrote in a note.

Hanold said he believes the top three takeover candidates are Noble Energy, Pioneer, and Concho Resources, the largest unconventional producer in the Permian. He notes that Noble has assets in the Permian and DJ basin and has significant free cash flow, while Pioneer, with one of the largest Permian positions, has core acreage in Midland and the Delaware basins, that can deliver organic growth of 10% and free cash flow over the next decade or longer.

Both Chevron and ExxonMobil are relative newcomers to the shale industry and both have made inroads into plays like the Permian Basin, where their heft has helped bring down costs.

Viewed as the hottest U.S. shale play, the Permian Basin, producing nearly 4 million barrels a day, is expected to see production double in coming years. Later this year, it will see a boost from the opening of new pipelines in the second half of 2019 that will take more of its oil to Gulf Coast refiners and to a new and growing U.S. export market.

The U.S. has become the world's largest oil producer because of the shale production boom. The U.S. produced 12.2 million barrels of oil a day in the past week, surpassing Russia and Saudi Arabia..

"This cements the trend of big oil becoming big shale," said John Kilduff of Again Capital. "Shell may be hearing footsteps in terms of competition, and I think BP will be looking around again. I do think this will start a land rush of deals."

Kilduff said higher oil prices have made deals more attractive, but they're not so high as to discourage buyers. "We're in a medium price environment. If you look at the futures curve out to 2028, the forward curve can support these deals and these valuations," he said. The price of West Texas Intermediate was at $64.50, up 1.5% Friday.

Chevron has not been shy that it was seeking acquisitions. The company also said in a release that it would look to upgrade its portfolio and potentially divest of $15 billion to $20 billion in assets between 2020 and 2022. The company said it expects the Anadarko acquisition to be accretive to free cash flow and earnings one year after closing, with a $60 price for Brent, the international oil standard. Brent futures were just under $72 per barrel Friday.

Chevron will assume $15 billion in debt as part of the deal, which must be approved by Anadarko shareholders. The company said that as a result of higher free cash flow, it plans to buy back more of its stock, increasing purchases to $5 billion from $4 billion per year.

"Generally speaking the small fries are targets. Anadarko had a net debt to capital ratio of 62%. The average E and P is more like 35%. I would say [targets] will have high debt levels or poor free cash levels," said Glickman. "Another thing Anadarko had working against it was its reserve life was pretty low."

He said among the type of companies that would be attractive targets are those with Permian exposure, and those with wells that are producing more oil than gas or natural gas liquids.

Glickman said a company like Parsley could be seen as a target since it is primarily located in the Permian and has a deficit cash flow.

"You can imagine every banker in the world is calling these companies," said one banker. He noted that potential targets just got more expensive, and it's not clear that buyers will necessarily bite. Bankers have been expecting not only a wave of mergers among public names, but also among private shale plays.

Chevron shares fell 4%. Based on Anadarko's closing price of $46.80 on Thursday, Anadarko shareholders will receive 0.3869 shares of Chevron and $16.25 in cash for each Anadarko share.

Correction: This story was revised to correct that the Thursday closing price of $46.80 was for Anadarko. Headlines also were revised to correct the spelling to Anadarko.