Oil and Gas Investor A&D Trends: M&A is the Bomb

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Consider the ampersand: that curvy wire that bonds together the undefusable explosive power contained within M&A. The ampersand even has a tiny fuse-like protuberance sitting at its bottom, ready to be lit.

Most analysts expect another year of high-intensity firepower from deals, largely directed at the Permian Basin, as well as the Marcellus and Haynesville shales. The recent Enterprise Products Partners LP announcement of Navitas Midstream Partners LLC for $3.25 billion only served to draw the Midland Basin in stronger contrast with its rival basins.

But the trajectory of 2022 deals will almost certainly cause different impacts than last year.

If commodity prices hold, investors will have to choose between the desire to decarbonize and the reality that the E&P industry will offer almost unmatched capital returns to investors while swiftly adapting to ESG needs—with a few notable exceptions.

Demand for oil and gas also goes against the grain of the financial sector in which banks and asset managers representing 40% of the world’s financial assets have pledged to align their portfolios with “science-based net-zero targets,” Moody’s Investors Service noted in a Jan. 6 report.

Unless a company has large-scale wind and solar farms, it isn’t likely to even be in the conversation. A June Investopedia article listed four oil companies as protecting the environment, all of them European and dabbling in renewables: Royal Dutch Shell Plc, TotalEnergies SE, Repsol SA and Equinor.

Despite that, as EQT Corp. CEO Toby Rice recently pointed out, “U.S. LNG powered by the Marcellus Shale is the biggest green initiative on the planet.”

As if to vindicate Rice, in early January, numerous news agencies reported that the European Union, suffering gas shortages, was planning to classify some natural gas and nuclear projects as “green” investments. Some Europeans activists were outraged at both natural gas and nuclear power even as they tolerate 25% of Germany’s power generation coming from burning coal, according to NPR.

In the U.S., consolidation could lead to benefits beyond company-specific scale and cost synergies. While public companies have taken pains to portray a “clean up their act” position on ESG, private companies are continuing to amp production and, as a result, drive emissions growth in 2022, Moody’s said.

Among the 100 largest oil and gas producers in the U.S., nine of the Top 10 greenhouse-gas emission-intensity producers are private, according to a report from the Clean Air Task Force and Ceres, a sustainability-focused think tank that Moody’s cited.

Consolidation can enhance the quality and durability of an E&P company’s drilling inventory and reserves, improve its product mix or basin diversification and help advance its long-term environmental objectives, Nymia Almeida, Moody’s senior vice president, said. “Financially speaking, consolidation can improve market access, reduce overall cost of capital, increase price realizations and lower breakeven costs,” she added.

Look for 2022 to also be a grittier, cash-heavy process. Deals will likely include more bolt-on acquisitions with private or small-cap companies. Larger companies will also look to monetize their noncore and Tier 2 acreage as they prune their portfolios.

Moody’s sees a shift from the zero-premium mergers that have dominated for more than a year.

“Buyers will likely have to pay a premium and more cash in future transactions,” the report said, “rather than the no-premium and all-equity deals of 2020, when valuations at cyclical lows left sellers without bargaining power.”

In the oil-weighted universe, the Permian Basin will naturally remain a dominate force. Several private and small companies remain with cost and infrastructure advantages as well as additional inventory, Moody’s said.

“Permian production has fully recovered to record levels as more companies diverted capital toward that basin in 2021. Volumes in other nearby basins still trail their pre-pandemic highs,” Moody’s said.

With plenty of free cash to burn, E&Ps will be looking at two alternatives: add high-quality inventory or return cash to shareholders.

For natural gas deals, higher prices and improved access to capital will allow larger gas-focused producers to chase M&A more easily in 2022. But the same higher valuations found in the oil patch will likely to be a motivator for sellers to engage “actively” with potential buyers.

For the remainder of 2022, look for deals to rain down like fireworks. The fuse is lit.