[Editor's note: A version of this story appears in the July 2020 edition of Oil and Gas Investor. Subscribe to the magazine here. It was originally published June 22, 2020.]

Don’t look to the supermajors to be M&A’s fire and rescue crew as the COVID-19 pandemic continues to burn down vast sectors of the economy.

Oil and gas companies such as Chevron Corp., Royal Dutch Shell, Total SA, BP Plc and Exxon Mobil Corp. are unlikely to pursue corporate M&A and will be selective in asset-level deals, according to a June 18 report by Cowen Equity Research.

Cowen analyst Jason Gabelman notes that equities haven’t benefited from large M&A activity since the 2014 downturn.

“One could argue M&A is part of the reason [Shell] cut its dividend and BP faces peer-high gearing. Occidental stock has suffered since its Anadarko acquisition,” the report said. “We believe it is unlikely supermajors will pursue wide-scale corporate M&A with independent E&Ps. The industry is in a corrective under-investment mode, making acquiring and accelerating likely moot while coming at the expense of leverage.”

Heightened uncertainty around oil demand recovery after COVID-19 remains a blight on the industry. Low oil prices continue to pressure oil and gas companies as well.

A Moody’s Investors Service June 10 report noted that in the previous downturn, shale production fell by about 600,000 barrels between second-quarter 2015 and third-quarter 2016. The recovery, such as it was, came after 28 months. The pandemic now looks to cut volumes by more than 2 million bbl/d and, Moody’s said, will take longer this time.

For the largest and most efficient shale producers, sustained prices above $40/bbl allow companies to earn adequate returns on investment. Stronger companies are also likely to engage in M&A.

“Corporate mergers and large acreage acquisitions abounded during the 2017-19 price recovery, consolidating assets among the financially stronger and more efficient E&P companies,” Moody’s said. “The pattern will repeat during the next recovery, although with less robust support from capital markets.”

Moody’s also predicts widespread bankruptcies are likely, with access to capital “prohibitively expensive” for high-cost operators since 2018. “Investors are likely to remain highly selective in allocating future capital to this sector, given its repeated underperformance,” the firm added.

With size and scale, supermajors appear to be the most natural asset aggregators, but price volatility makes asset-level transactions more likely, Cowen’s report said.

“We do not necessarily think M&A is imminent,” Cowen researchers said. “Chevron could be [the] most likely to acquire in the downturn given a peer-leading balance sheet and investor concerns around longer-dated backlog.”

Chevron has noted that a slowdown in its Permian Basin production extends its production horizon. The San Ramon, Calif.-based company has also said it prefers corporate-level M&A rather than asset acquisitions because it’s easier to find synergies.

Additionally, Cowen research found that, since the prior downturn, large-scale M&A has generally “produced suboptimal returns.” This could make companies think twice about moving forward with deals, which have cost majors an average $55,000 per flowing boe.

Further, E&Ps appear unlikely to sell at the bottom of the cycle unless they are under financial distress. E&P companies in Cowen’s coverage universe are capable of generating free cash flow with prices in the upper $30s/bbl in 2021, the firm said.

Other companies are likely to be besieged.

Restructuring specialists have reported being swamped by clients seeking help with their finances. Many experts expect a massive change in finances for the companies, including likely bankruptcies.

On June 14, Denver-based Extraction Oil & Gas Inc. became one of the latest oil and gas companies to file for Chapter 11 bankruptcy protection.

“Widespread bankruptcies will likely also facilitate more sustainable long-term volume growth among better-capitalized producers,” Moody’s said.

Moody’s puts the timetable for recovery in the mid-2020s. The credit rating service said oil prices could recover significantly by 2022, with financially stronger companies further consolidating shale assets.

“A shale recovery will still need higher prices and take several years,” the firm added.

And public equity continues to suffer. Bernstein Energy research, published June 8, suggested that at current prices, oil companies’ reserves are currently valued on an enterprise value per boe basis at $10/boe, with more inexpensive companies trading at $5/boe.

Bernstein said that, last year, reserve replacement costs last year were about $17/boe, “implying that it is again cheaper to drill in [the] stock market than in the ground.”

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