M&A could increase in 2006, according to a report by PricewaterhouseCoopers' transaction services group. "We think it's very possible the industry will see some large M&A deals next year, both in the U.S. and globally," says Rick Roberge, PwC global leader, transaction services, in the Houston-based energy practice. "Many of the larger companies have been content to sit on their cash war chests in 2005. But at some point, commodity prices will settle and companies will begin drilling higher-risk projects using higher midcycle prices. That's when consolidation will accelerate because of the need for larger balance sheets to reduce those risks." There are certain main factors that will affect the amount of M&A activity in the coming year, he adds. Commodity-price volatility will continue to limit excessive drilling; companies have not factored higher prices into project economics, thus limiting spending. "As prices soared over the last two years, investment levels at the 20 largest oil and gas companies, as a percentage of cash flow, have fallen from 46% to 36%." M&A will be more attractive when prices settle, Roberge says. Many producers are buying their own stock. "While buying back shares is clearly preferable to raising dividends as a means of returning excess cash to investors, both are up this year as a percentage of cash flow." Buybacks have increased from 7% to 18% in the past two years, he says. Unafraid to do deals in the midst of volatile commodity prices are global buyers such as CNOOC and CNPC, which are often financed by their own governments, he adds.

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