Royal Dutch Shell’s proposed $70 billion acquisition of BG Group is reminiscent of the megamerger consolidation period between the majors in the late 1990s, and is by far the largest deal since that era. After years of speculating that the oil and gas industry has been ripe for corporate M&A, does the Shell-BG marriage portend a catalyst for combinations?

At least two analysts think so.

“The acquisition of BG is arguably one of the biggest and boldest transactions in the industry this century,” Bernstein Research analysts, led by Neil Beveridge, wrote in an April 10 research note. “The question for investors is whether this deal is a ‘one-off,’ or whether it launches a frenzy of M&A activity. We think the latter.”

Morgan Stanley Research analyst Evan Calio said in an April 10 report that he too expects upstream consolidation. “Just as there are more equity investors focused on energy than any time in my career, there are also more corporates focused on the opportunity to accretively or strategically add resource in the current downcycle that is now two quarters old.”

The Bernstein analysts argue that you know the M&A cycle has begun when “it’s cheaper to drill in the stock market than in the ground,” referencing T. Boone Pickens’ theorem in the consolidation period during the 1980s. “Every 15 years, there is a need for the oil and gas industry to restructure or consolidate through M&A. This moment appears to have arrived.”

Their reasons: First, the collapse in oil price has led to considerable uncertainty. “M&A intensity has always increased during periods of price instability.” Second, the cost to acquire reserves is arguably cheaper than to develop them for many E&Ps. Third, reserves replacement has been weak for many large-cap companies and majors, implying it is only a matter of time before companies are forced to acquire assets to shore up production.

But the most compelling reason for M&A today is that industry returns have dropped below the cost of capital, similar to levels in the 1990s M&A boom, Bernstein said. “If the cost structure of the industry cannot be improved sufficiently, then it seems likely that the industry will be forced to consolidate sooner rather than later.”

Calio points to the current restructuring of U.S. E&Ps to large cash positions and a stated ambition to increase unconventional resource exposure—but in the face of a wide bid-ask spread in the asset marketplace—as a compelling factor for corporate transactions.

“In a world of low interest rates and a large number of potential and interested buyers, we are skeptical values will get ‘cheap,’ particularly for Tier 1 and Tier 2 inventory,” said Calio. “We believe the dynamic nature of value in U.S. unconventional [assets] with improving efficiencies, EURs and locations may also provide upside versus current perceived value.” This “dynamic NAV” concept thus makes U.S. E&Ps less expensive than the market perceives, he said.

And with a plethora of private-equity capital expected to compete for assets, “we think the market is setting up for a chase. Offering stock as a consideration could help buyers and sellers agree on price as a way for sellers to share in the upside.”

Calio’s list of large caps with capacity and desire to acquire includes ConocoPhillips, Apache, Occidental, Murphy, Marathon, Devon, EOG and Hess. Without naming names, Beveridge seems to concur.

“Going forward, we expect that distressed, smaller E&Ps with reserves and acreage will be bought by larger rivals that have better balance sheets and can cut costs by being more patient in developing acreage and reserves,” he said. “While this has been slow to play out, it seems inevitable that this will have to happen.”

But what about the supermajors? Calio thinks ExxonMobil and Chevron are best positioned to impact the U.S. playing field. Both referenced M&A potential in recent analyst days.

“The two supermajors are built for down-cycle acquisitions and are most likely to be opportunistic,” he said. Integrated cash flows, balance sheet strength, and yield-supported valuations result in a premium to other E&Ps, making equity deals advantageous. ExxonMobil would most likely seek offshore exposure or international assets, Calio said, while North American unconventional would have more strategic appeal to Chevron.

My take: While a handful of handshakes are destined to take place in the next 12 to 18 months, the only factor that will lead to widespread consolidation is long-term low commodity price pain. The industry might be due a good sweating, but who really wants that? Again, we wait to see if the era of M&A has returned.

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