Pumpjacks work in a field near Lovington, N.M. on April 24, 2015.Charlie Riedel/The Associated Press
Takeovers are reshaping the North American oil and gas industry.
The largest U.S. energy companies are snapping up smaller rivals in a series of US$20-billion-plus deals. Canada’s mid-tier producers – Tourmaline Oil Corp. TOU-T, Peyto Exploration & Development Corp. PEY-T, Baytex Energy Inc. BTE-T and Crescent Point Energy Corp. CPG-T – also spent the past six months aggressively acquiring properties with billion-dollar-plus price tags.
On both sides of the border, dominant players are emerging in key regions – the Permian basin in Texas, Bakken formation in North Dakota and Western Canada’s Montney and Duvernay basins.
Notably absent from the latest round of deal-making: Canada’s largest oil and gas companies.
Canadian Natural Resources Ltd. CNQ-T, Suncor Energy Inc. SU-T, Cenovus Energy Inc. CVE-T and Imperial Oil Ltd. IMO-T – all companies with $40-billion-plus market capitalizations – have been on the sidelines while peers take part in a flurry of merger-and-acquisition activity.
This simply cannot last.
The country’s four largest oil and gas producers aren’t immune from the factors driving industry consolidation, including an investor fixation on increasing reserves and operational scale. And Canada’s energy players, like their U.S. peers, boast strong balance sheets and ambitious executive teams. Before this M&A cycle is done, the country’s biggest energy companies are bound to get bigger.
The current wave of oil patch M&A kicked off in earnest last October. In the space of a month, market leaders Exxon Mobil Corp. XOM-N and Chevron Corp. CVX-N dropped a combined US$112-billion on two takeovers. Both deals were warmly received.
“The market has bestowed mega-cap exploration and production companies (market cap greater than $40-billion) a higher valuation than the broader large-cap peer group,” Bank of Nova Scotia analysts Paul Cheng and Jason Bouvier said in a report on Monday. “We think many investors, especially long-only accounts, place a premium on scale which enhances operational resilience and trading liquidity.”
The market’s fixation with scale helps explains the enthusiastic reception Diamondback Energy Inc. received on Monday when it launched a US$26-billion bid for Endeavor Energy Resources LP. The deal will create the largest pure-play Permian producer. Midland, Tex.-based Diamondback’s share price jumped by 8 per cent after it announced the acquisition.
Diamondback included US$8-billion of cash in its stock-and-cash bid for Endeavor, and will borrow to fund the acquisition. In the past, debt-financed takeovers have come back to bite energy companies, as commodity prices fell and buyers struggled to make interest payments.
The dynamic is different in this cycle. Balance sheets are so strong that a company like Diamondback currently hands over 75 per cent of the cash it generates to investors, in the form of dividends and stock buybacks. By cutting its payout ratio to a reasonable 50 per cent of cash flow, Diamondback can quickly pay down acquisition debt.
Canadian Natural Resources, the country’s largest energy company by market capitalization, is in even better financial shape. It forecasts paying out 100 per cent of free cash flow to investors this year, and returned $6.1-billion to shareholders in the first nine months of 2023.
With cash to spend and reserves to build, what are Canada’s energy leaders going to buy? Recent acquisition activity, and common sense, dictate the takeover targets will be junior companies with properties in the same neighbourhoods as the seniors.
On Monday, investors bid up share prices at domestic energy plays that analysts predict will be dinner, not diner, during this wave of acquisitions.
Last October, The Globe and Mail highlighted mid-sized domestic producers Surge Energy Inc. SGY-Y, Kelt Exploration Ltd. KEL-T and Advantage Energy Ltd. as potential targets. Shares in all three Calgary-based companies jumped after Diamondback announced the latest energy megadeal.
In Alberta’s oil sands, where companies have been consolidating for more than a decade, recall that at least one producer – MEG Energy Corp. MEG-T – fought off a hostile bid, only to see its spurned suitor grow far stronger.
In 2018, Husky Energy made an unsuccessful $6.4-billion offer for MEG. Two years later, Cenovus acquired Husky.
A deal that made sense for Husky would be a no-brainer for Cenovus, a deeper-pocketed and far more committed oil sands operator. Last year, the Calgary-based company bid for two oil sands properties put on the auction block by France’s TotalEnergies SE, only to see ConocoPhillips Co. use its right-of-first-refusal to grab part of the prize.
Canada’s largest energy companies are awash in cash and hungry. They haven’t been heard from in this wave of oil patch deal-making. They will likely be making noise in the near future.