Our takeaways from the Conoco-Concho merger


ConocoPhillips’s $9.7bn deal for Concho Resources shows that the long-expected shale consolidation phase is well and truly under way. It will not be the last takeover in the US’s battered oil patch — as news of talks between Pioneer Natural Resources and Parsley Energy shows.

Our first note looks at what was behind the Conoco-Concho deal. Opec’s latest meeting, held against the worrying backdrop of the second coronavirus wave and renewed lockdowns, is the topic of our second.

Thanks for reading. Please get in touch at energy.source@ft.com. You can sign up for the newsletter here. — Derek

Conoco goes for shale scale

Ryan Lance, ConocoPhillips chief executive, said yesterday that the shale sector’s “consolidation is both necessary and inevitable”. After the recent Chevron-Noble Energy deal and Devon Energy-WPX merger, Mr Lance’s acquisition of Concho Resources shows that the inevitable has arrived.

Here are the key points from the transaction:

Scale: The addition of Concho, which produced 200,000 barrels a day of oil in the third quarter, will make Conoco the world’s largest independent oil company, with output of around 1.5m barrels a day.

Price tag: Including debt, the $9.7bn deal value rises to $13.3bn, according to Citibank, making it the biggest shale-focused acquisition in the wake of the 2020 oil-price crash.

Permian focus: Conoco yesterday emphasised the breadth of its shale position in the US — but this deal was about the Permian, where Concho is a leader. The combined company will have 700,000 acres to drill in the Permian’s Delaware and Midland basins. Concho’s cost of supply in the Permian is “in the low to mid-$30s”, Conoco said yesterday — a benefit to Conoco, one of the first operators to curtail expensive production when oil prices plunged earlier this year.

Column chart of Tight oil completions since Jan 2019 showing Deal multiplies Conoco's Permian footprint by factor of eight

Break-even: All told, Conoco said the combined entity would enjoy free cash flow break-even oil prices of $34 a barrel. Add in the dividend — continued payment of which would remain a “first priority” — and costs would be covered at $41/b.

Biden risk: Despite deepening its position in the Delaware’s federally controlled acreage in New Mexico, Mr Lance was “comfortable with the risk” that a Biden administration, if elected, could change leasing rules. Both companies “have enough assets on the nonfederal acreage to support development for a decade and beyond”, he said.

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Market reaction: Share prices for both companies were flat after the deal was confirmed — the market had already digested rumours of the move, reported by Bloomberg earlier this month. Most analysts liked what they saw. Some said it marked a vote of confidence in US shale.

“[Conoco] has been one of the most diversified of its peer group, and was likely part of the reason its performance has been so stellar. Doubling down on the Permian reduces portfolio diversification and feels counter cyclical to the idea that US E & Ps are going to start looking internationally because tight oil is out of favour,” said Alex Beeker, principal corporate analyst at Wood Mackenzie.

Bar chart of Tight oil completions since Jan 2019 showing Concho buy catapults Conoco into the big league of shale operators

Size matters: “Today, scale has never been more important,” said Tim Leach, Concho’s chief executive, who will join the Conoco board. Tudor Pickering Holt & Co said that by gaining scale, Conoco now has “a solid investment opportunity to own crude leverage when the environment improves”.

Bargain hunting: Low-cost equity deals are the new M&A model in a shale patch where no one wants to spend cash. At 15 per cent, the premium Conoco will pay Concho’s shareholders is better than that paid by Chevron for Noble Energy. But at a market capitalisation of $9.7bn, a huge windfall it is not. Concho’s market cap at the start of the year was almost twice as great.

“We have long believed that nil-premium mergers would be the pathway for US shale equities. While the underlying resource is extremely competitive (low cost, short payback, long asset life), the industry is too highly fragmented with too many managements, too much G & A, too much growth ambition and too little focus on shareholders,” said analysts at Citibank.

Which companies are next? Concho’s Permian rivals Pioneer and Parsley appear next in line. Diamondback Energy, Cimarex Energy and EOG Resources are all candidates, but the list of possible buyers is thinning.

Andrew Gillick, strategist at consultancy Enverus, said the market would only reward deals that “extend the runway” of drilling locations, maintain or lessen debt, and involve limited premiums.

“There are very few remaining companies in the shale patch that fit this bill, which suggests much more restructuring, as opposed to M&A, in future,” Mr Gillick said.

(Derek Brower and Myles McCormick)

Opec frets about the market again

Oil ministers gathered virtually on Monday against a backdrop of an uncertain market outlook, with investors and analysts keeping an eye out for signs that producers may delay a further easing of the supply cuts in place since May.

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Opec delegates have signalled they favour pushing back a scheduled tapering due in the new year by a few months, but any such action would require Russia’s buy-in. While Moscow is part of the collective cuts deal, it is reluctant to lose market share to rivals.

Without giving much away, Saudi Arabia’s energy minister Prince Abdulaziz bin Salman sought to emphasise that come what may, producers will continue to work together to manage the market.

“We will not dodge our responsibilities,” he said as officials met to monitor the progress of the cuts deal. “We will do what is necessary.” Supply curbs of 9.7m barrels a day were agreed in April and have since been reduced to 7.7m b/d.

‘Make my day’: Saudi Arabia’s Prince Abdulaziz has vowed that Opec+ will continue to work together to manage the market © REUTERS

The pressure is building on producers to take further action, with the oil market’s recovery since the summer months having stalled.

The supply picture is in question too with new production set to come online from Libya. Other countries that have failed to meet their share of cuts have also not yet compensated fully for their overproduction.

“There is still some work to do,” said Prince Abdulaziz.

To add to the uncertainty, a presidential election in the US is just two weeks away, which could fundamentally alter how the country interacts with major producer nations — namely Saudi Arabia and Russia.

Russia may be reluctant to co-operate, but it knows the market is fragile. “Despite the [oil price] stability which we’re seeing today, it is clear that the market is much more volatile than it may seem,” said energy minister Alexander Nobak.

Prince Abdulaziz had a parting shot for doubters — ahem . . . short-sellers — that might want to bet against producer countries. (Yes, we also remember the Saudi-led price war earlier this year.)

“It would be unwise indeed if anybody wants to gamble on our determination . . . Again, please make my day,” he said.

(Anjli Raval)

Data Drill

The cost of generating power from utility-scale solar has fallen a staggering 90 per cent since 2009, according to new analysis by investment bank Lazard.

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The group’s latest Levelised Cost of Energy report, released this week, underlines the extent to which decreasing capital costs, improving tech and increased competition have sent the price tag of renewable power tumbling over the past decade. Wind generation has fallen 70 per cent.

“We just see a continued decline in the cost of renewable energy relative to conventional generation,” said George Bilicic, global head of power and energy at Lazard. “And so whether it’s an established, existing fossil fuel plant . . . or a new one, renewables are competitive.”

Line chart of $/MWh showing The cost of renewable power has plummeted in the past decade

Power Points

Endnote

The energy transition is under way — at least as far as investors are concerned. A survey from BCG’s Center for Energy Impact of 150 oil and gas investors offers stark findings:

  • Just 26 per cent of respondents think oil and gas will gain a bigger share of their portfolio in the next decade.

  • Only 30 per cent think it remains more attractive an investment than renewables.

  • Almost 60 per cent feel pressure to cut fossil fuels from their portfolio.

  • Almost 90 per cent think clean energy is a way for oil and gas companies — from majors to midstream players — to position for long-term success.

  • Sixty-three per cent of investors surveyed thought companies should pursue ESG goals, even at the expense of lower earnings per share.

The souring on oil and gas isn’t because investors are bearish about the market: 77 per cent think demand will recover in 2021, 59 per cent think prices will be $40-50 a barrel in 2024 and 30 per cent think it will be even higher.

Rebecca Fitz, a senior director at the CEI, said it marked a warning for the oil sector.

“The shift to low carbon won’t happen overnight, but investors are strongly signalling support for greener portfolios, and scepticism for traditional oil and gas value creation models in the years ahead,” she said.

Energy Source is a twice-weekly energy newsletter from the Financial Times. Its editors are Derek Brower and Myles McCormick, with contributions from David Sheppard, Anjli Raval, Leslie Hook and Nathalie Thomas in London, and Gregory Meyer in New York.



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