A wave of M&A activity has been expected in the US oil and gas industry for some time. However, until last week, a lack of deal activity in the sector prompted investors to question the consolidation theme.
On 12 April, oil major Chevron announced its intention to acquire US exploration and production company Anadarko, for an enterprise value of $50bn. The deal values the equity at $33bn, which Chevron will fund with shares ($25bn) and cash ($8bn) – and it is the first large M&A deal from a major integrated oil company since the decline in crude prices began in 2014.
The importance of scale in an industry inherent with cash flow volatility
Anadarko’s acquisition will strengthen Chevron’s business by adding more than 10bn barrels in the Permian Basin, deep-water Gulf of Mexico and Anadarko’s Mozambique LNG project.
The new enlarged entity is set to become the largest Permian Basin producer and the second largest producer of US shale oil. Indeed, as shale is shorter-cycle and thereby less risky than mega projects, Chevron’s move is an effort to high-grade its operating portfolio.
In addition, the combined company is expected to deliver annual synergies of approximately $2bn – that’s compromised of $1bn operational savings and $1bn capital efficiencies.
In our view, this transaction highlights the strategic importance of scale, lower costs and efforts to de-risk operations in an inherently volatile commodities environment.
Further consolidation is on the horizon
We believe consolidation in energy space will continue in the following ways:
- larger, better capitalised companies will acquire smaller shale or offshore players to create more contiguous acreage positions; or
- smaller companies will merge to benefit from larger scale developments.
To our mind, further consolidation would allow companies to lower costs and accelerate the transition to growth through cash flow – a dominant theme in the energy sector since autumn 2017 (see our commentary Back in black: The energy sector’s cash flow focus is good for credit).
In addition, valuation multiples for some energy companies are potentially still attractive, given their underperformance against the S&P 500 and the oil rally this year (see Figure 1).
Figure 1: Anadarko has underperformed the S&P 500 in 2019
Source: Bloomberg as at April 2019.
Global credit markets are wide open, particularly for high-quality energy issuers
To fund the transaction, Chevron will need about $8bn of cash along with $2.5bn of maturities in 2019. And while the company had $9.4bn of cash at the end of 2018, we would not be surprised if it decided to tap unsecured capital markets to fund a portion of the deal (historically Chevron has operated with a high cash balance).
What’s more, as Chevron has a strong credit profile (Aa2 Stable from Moody’s), we do not expect the company to have any problems in accessing unsecured debt capital markets. In fact, our view can be further supported by Saudi Aramco’s inaugural $12bn issuance earlier this month, which was approximately 10x oversubscribed.
Why is the deal positive for energy credit?
The Chevron-Anadarko merger announcement reaffirmed that the consolidation theme is still very much in play in the energy sector. On the day, it was very well received in both credit and equity markets, with the majority of US investment grade issuers trading 10-30bps tighter, high yield issuers up 0.5-2bps and Permian-exposed equities rallying 8-10%.
As previously mentioned, we see more consolidation in the energy sector. We believe that it is important to own names that are attractive both on their own and as potential beneficiaries of the consolidation trend. These include:
- current holding Plains All American (PAA), a midstream company that benefits from growing volumes in the Permian Basin;
- one of our holdings Hess, an exploration and production company that has an offshore joint venture with Exxon in Guyana; and
- WPX Energy, another exploration and production company we invest in with high quality acreage in the Permian Basin.
Of course, the Chevron-Anadarko deal raises the inevitable question of who’s next. The transaction has undoubtedly reinvigorated the energy industry – and so, we will watch this space.