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Here's Why Energy M&A is Expected to Remain Healthy in 2020

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Mergers and acquisitions (M&A) activity among upstream energy companies surged to a five-year high of $96 billion in 2019, thanks to mega deals such as Occidental Petroleum’s (OXY - Free Report) buyout of Anadarko Petroleum.

While a number of companies struck deals to increase scale and stay competitive, some transactions were driven by the need of diversification across geographical coverage.

Here is an overview of the five major proposed exploration and production energy deals from 2019:

1.    Occidental-Anadarko

In early August, Occidental completed a $57 billion (including debt) mega-merger deal with Texas-based upstream company Anadarko Petroleum after it prevailed in a bidding war with supermajor Chevron CVX. At stake was Anadarko’s 250,000 net acres in the fastest growing oil producing region in the world - the Permian basin spread over west Texas and New Mexico. Occidental’s motive was to become the largest crude producer in the Permian Basin, where it owned maximum acreage (around 2.5 million acres) followed by Chevron (2.2 million acres).

Per Occidental, the combined company boasts a production capacity of 1.3 million barrels of oil equivalent per day and is expected to be accretive to free cash flow within a year of the acquisition. It is also on track to generate $3.5 billion of free cash flow through $2 billion of annual cost synergies and $1.5 billion of annual capital reductions.

2.    BP-Hilcorp Energy

In August, BP plc BP announced that it has signed an accord with privately held Hilcorp Energy Co. to divest all its assets in Alaska for $5.6 billion. With the deal's anticipated closure this year, subject to approvals from the state and federal bodies, the British energy giant will exit Alaskan operations after 60 long years.  

Precisely, the assets to be divested entails BP’s entire upstream and midstream operations in Alaska. This includes the British energy giant’s stake in the Prudhoe Bay — the largest oil field in North America — and the Trans-Alaska Pipeline System — spreading over 800 miles and transporting oil to the Port of Valdez.

3.    Callon Petroleum-Carrizo Oil & Gas

The deal frenzy continued to sweep the U.S. oil industry, bringing about a wave of consolidation in the prolific shale plays. Another energy company to join the bandwagon was Callon Petroleum Company CPE, which, in July, announced the acquisition of Carrizo Oil & Gas, Inc. in a $3.2-billion deal (including debt), in a bid to bolster its Permian presence.

After months of opposition from some large shareholders, the transaction was eventually completed late last year on a revised buyout price and conditions.

The combined company is expected to have around 200,000 net acres in the Permian Basin and Eagle Ford shale. While the addition of Eagle Ford acreages to Zacks Rank #2 (Buy) Callon Petroleum’s portfolio meant that it lost the pure-play Permian status, the move will likely trigger economies of scale and lead to significant cost reduction.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

4.    WPX Energy-Felix Energy

Mergers in the upstream space continued throughout the year when WPX Energy WPX announced in December that it intends to acquire Delaware Basin-based Felix Energy for $2.5 billion. The purchase consideration comprises $900 million in cash and $1.6 billion in WPX Energy shares. This acquisition is in sync with the company’s intention to further increase oil production. 

Felix Energy has nearly 1,500 gross undeveloped locations in the eastern portion of the basin, with expected production of around 60 thousand barrels of oil equivalent per day. Out of the total production, 70% will be oil. The parties anticipate closing the transaction early in second-quarter 2020.

5.    Parsley-Jagged Peak

In October, Parsley Energy PE reached an agreement to acquire smaller rival Jagged Peak Energy JAG in an all-stock deal worth $2.27 billion comprising $625-million net debt as of Jun 30. Per Parsley Energy, this “low premium” deal will leave an immediate positive impact on its 2020 cash flow along with net asset value and returns on invested capital. Additionally, the Permian pure play will be able to curb general and administrative costs by almost $25 million in the first year followed by $40-$50 million annual savings subsequently.

Parsley Energy’s assets are said to well complement Jagged Peak’s high-margin, oil-heavy assets in the Delaware Basin. The integration between the two companies is expected to make a significant contiguous impression on the Delaware Basin, resulting in more optimized lease geometry with additional extended lateral walls. The transaction is expected to close by the first quarter of 2020.

Expect More Oil Patch M&A in 2020

Upstream companies are currently under pressure from investors, who are no longer supporting drilling programs and expansions in the absence of strong cash flows. Investors want these companies to reduce costs, improve internal efficiencies, raise share repurchases and increase returns.

One of the ways to tide over the low returns and weak cash flows is consolidation. In fact, mergers are viewed as a means to build scale and minimize overhead costs, thereby creating a stronger company with improving efficiencies and financial performance.

As it is, a prolonged period of low oil prices has led to ‘survival of the fittest.’ Larger companies – especially those with cash to spend – are set to take advantage of this opportunity and buy quality assets at cheap valuations. The most vulnerable companies are the ones with increasing levels of debt and distresses assets.

Finally, with WTI crude, the domestic benchmark, bouncing back above $60 per barrel on multiple tailwinds, the investor hunger for M&A deals is likely to remain strong. The flurry of such activities in recent times suggest that stronger companies are lining up to buy the weaker ones.

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