Oil and Gas Investor A&D Trends: So Little Noises

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In a Monty Python skit, two East End London gangsters try to shake down a British army colonel with a not-so-subtle threat. “This is a real nice army base you got here, colonel,” one of them, wearing a pin-striped suit and dark sunglasses, says. “Be a shame if something were to happen to it.”

This is essentially the same pretext given for Royal Dutch Shell Plc’s surprise decision to sell off its Permian Basin assets. But many questions arise.

The backstory: In May, a Dutch court ordered Shell to abide by stricter rules in lowering its greenhouse-gas (GHG) emissions. Articles by Reuters have since given this as the explanation for the Dutch-Anglo company’s willingness to sacrifice what it once called the “heart of Shell’s shales portfolio” that was to set the stage for growth across the Americas.

The result, in September, was a supersized deal in which ConocoPhillips Co. will buy Shell’s tightly packed, blocky Permian acreage position for $9.5 billion.

It was therefore interesting to hear ConocoPhillips trumpet, more than once, how far the transaction would go toward helping the Houston company reduce its emissions. The company said Shell’s assets, including infrastructure, would help lower its GHG emissions by 40% to 50%, based on a 2016 baseline. ConocoPhillips’ previous target was a 35% to 45% reduction.

Is it possible that a single megadeal cooled two birds with one stone? No.

Rather both companies simply look better because ConocoPhillips emissions aren’t great—Fitch Ratings graded a number of the company’s energy transition standards with a resolute “poor.”

Shell, by simple attrition, is cutting its emissions, but its overall E&P operations were scored as so-so by Fitch. Also, Shell said that since 2017, it has reduced its Permian GHG emissions and methane intensity by 80% through “investment in infrastructure and technology.”

In 2018, for instance, Shell’s U.S. president, Gretchen Watkins, said the company was working to reduce flaring and had stopped installation of new flares at well production pads.

In short, the story is that Shell’s premier shale business, which it had invested money and time to curb GHG emissions, was the best asset for it to ditch as it strives to meet a court order it plans to appeal.

Also of note was the deal’s financial metrics. Shell’s Permian business includes ownership in about 225,000 net acres with production of about 175,000 boe/d. (ConocoPhillips rounded its estimated 2020 production to 220,000 boe/d.)

Subtracting production, the transaction cost ConocoPhillips about $15,600 per net acre, according to Wells Fargo Securities.

As the Permian goes, that’s a solid price for Shell, though far from the days when acreage hovering over Permian Basin caused grown adults to cry havoc and let slip bids of $90,000 per acre.

Shell’s Permian business recorded close to half a billion dollars of pre-tax losses in 2020. Of course, that was the year every oil and gas company was roasted over a commodity-fire pit. The Permian business recorded a before-tax operating loss of $491 million for the year ended Dec. 31, 2020. The transaction is expected to result in an after-tax gain of $2.4 billion to $2.6 billion, subject to adjustments. And Shell took $9.5 billion for assets that it valued at $10.5 billion at the end of 2020.

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ConocoPhillips paid for the deal with $4 billion of cash on hand and its balance sheet, but its long-term debt reduction goals won’t be affected as a result of the deal, said Roger Read, senior analyst at Wells Fargo. The company also expects $10 billion of free cash flow—a 15% increase—by 2030.

Bob Brackett, senior analyst at Bernstein, said in a September report that ConocoPhillips was one of the few companies with a balance sheet big enough to absorb the assets Shell wanted to shelve.

“We wonder out loud whether Permian assets are becoming more attractive as geopolitical pressures mount elsewhere in the world, and perhaps even the North Slope,” Brackett said. “Ultimately, the fewer, larger and more disciplined hands that control the Permian—and shale more broadly— the better, so COP [ConocoPhillips] as an expanded force for discipline is good for our thesis.”

So why does it feel like a $9.5 billion deal has all the significance of a tree falling in a forest with just enough people around to hear it? Perhaps because nothing significant changed in the Permian’s deal world.

Isn’t one person’s ConocoPhillips just another Shell? And emissions, likely, didn’t change either.

Even the concept of consolidation is somewhat surreal. ConocoPhillips plans to bust up its own acreage and sell up to $4 billion in assets, mostly in the Permian.

That’s the Permian. A $9.5 billion deal—and so little noise.