TALES OF THE TAPE: High Prices Keeping Lid On Big Oil Deals



HOUSTON (Dow Jones Newswires), August 6, 2008

Although flush with cash due to high oil prices and hard-pressed to increase production, major oil companies aren't ready to make large-scale acquisitions, at least not yet.

Industry watchers don't think the current political climate is conducive to consolidation, because oil companies fear becoming a target in a presidential campaign season that has increasingly spotlighted energy policy. The other, perhaps larger impediment is high oil and natural gas prices, which would make a takeover of the most likely targets prohibitively expensive.

"Prices have come down in last days, but the political environment is still a bit difficult," said Phil Weiss, an analyst at Argus Research in New York. "I'm not sure that possible targets are trading at the kind of discount one of the majors would be looking for should it make an acquisition."

While swaps and acquisitions of assets are still commonplace in the energy sector, the mega-mergers that created the likes of modern-day BP PLC (BP), Chevron Corp. (CVX) and even Exxon Mobil Corp. (XOM) itself have petered out. One scenario sometimes discussed is the takeover by a supermajor of a large independent such as Devon Energy Corp. (DVN) or Apache Corp. (APA), which have extensive leverage to the hot North American natural gas market.

But while there are strategic benefits to such a deal, the timing is bad, analysts said. U.S. independents like Apache and Devon have been among the strongest equities within the petroleum complex in 2008. Their stocks have receded in recent days, but they are still trading at high prices.

"We are just going about doing our business," Devon President John Richels said in an interview. "No one is knocking on our door."

So far, oil giants have used a big part of their cash from high prices to boost share-repurchase programs and increase dividends. This decision has steered the cash to investors, but hasn't resolved the two biggest challenges companies face: declining production and shrinking reserves.

But making acquisitions in a seller's market at record high oil and gas prices would reflect poorly on the buyers and their limited options to maintain, let alone grow, production and replace reserves, said Fadel Gheit, an analyst at Oppenheimer & Co.

"I don't think we will see more significant acquisitions in this environment in the short term," Gheit said. "If I see Exxon making a move at these prices, then I'll throw the towel and say oil companies have acknowledged defeat."

Any kind of transaction would have to be able to move the needle from a production perspective, which for a company the size of Exxon, could mean buying a large independent producer or even another major oil company.

"If a major oil company was going to make an acquisition, it would likely be one of the larger independents, like Apache or Devon," said Weiss. "My take is that at least for now, both companies would prefer to remain independent, and that prices are too high for a deal to take place."

A Seller's Market  

Apache and Devon are small enough to be acquired, but big enough to make a difference in the production and bottom lines of the buyer, said Tim Hanson, senior analyst at the Motley Fool, an investment and financial-services company in Alexandria, Va. Apache and Devon have market capitalizations of $35 billion and $55 billion, respectively.

Both companies have valuable onshore U.S. natural-gas assets, which are currently in high demand as the region has become one of the most profitable in the world. Apache declined to comment for this story.

If consummated, such a deal would be a bigger version of the few transactions that oil majors have executed in recent months. BP PLC announced in July that it will pay Chesapeake Energy Corp. (CHK) $1.75 billion to acquire natural-gas assets in Oklahoma. BP's announcement came three days after rival Royal Dutch Shell PLC (RDSA) announced a near-$6 billion takeover bid for Canadian natural-gas producer Duvernay Oil Corp., also considered a top-dollar move.

For years the largest oil companies ignored the onshore U.S. in favor of international ventures, but as oil-rich countries have tightened the grip on resources due to high oil prices, North America is beginning to look like a better bet.

Independent companies like Apache or Devon have been able to increase reserves and output as they learned how to produce oil from unconventional reservoirs that were considered too difficult or expensive to produce.

As independent producers have flourished, so have their stock prices. Shares of both companies were up more than 30% until last month compared with the beginning of the year. But with the drop of natural gas prices under $9 a million British thermal units on Monday their shares were trading practically flat this week compared with the beginning of the year.

Analysts say the shares of large U.S. independent producers could become even more inexpensive next year if energy prices retreat more.

The shifting industry terrain has cast a more benign light on ConocoPhillips' (COP) 2006 acquisition of Burlington Resources for $35 billion, which was initially criticized as an expensive binge. But as natural gas prices have steadily risen, the deal is starting to look clever, and some say it could make others follow suit.

Conoco Chief Executive James Mulva said recently the company is not planning to do a multi-billion acquisition but that it will continue to buy assets.

Even if prices of natural gas would stumble and along with them the stock price of possible targets, some say independent producers still wouldn't be the best fit for oil giants. This is because although unconventional natural-gas assets have become more valuable they still require hundreds of small wells managed by large numbers of employees that make it difficult for a large oil company to obtain a great return.

Gheit thinks the market will probably see consolidation before the end of the decade, but not by big and large independent oil companies, but involving the two largest U.S. oil companies by market value: Exxon and Chevron.

Almost a year ago, the same idea was floated by Credit Suisse in a note released after analyst Mark Flannery interviewed Exxon Chief Executive Rex Tillerson.

According to Credit Suisse, Exxon would be open to a large deal in the public markets when the time is right. The financial firm said Exxon's preferred target would be Chevron. Neither company has commented on the report.

(Jason Womack contributed to this report.)

Copyright (c) 2008 Dow Jones & Company, Inc.


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