Majors expanding visibility in US upstream sector

The withdrawal more than a decade ago of the major integrated oil companies from the upstream energy segment in North America amid apparent dwindling conventional reserves has had a profound effect on the energy sector, particularly in the lower 48 US states. The consequences of this withdrawal were twofold:

The exodus of the oil majors to the far corners of the globe thrust them into the role of true international firms along the lines of their European counterparts - BP, Total, and Royal Dutch/Shell Group; and it enabled them to increase their revenues exponentially. In short, it was a smart move.

The vacuum left behind in North America led to the creation of many new E&Ps (aka “bottom feeders,” according to conventional wisdom), a number of which have become “super independents” with annual net income in the billions of dollars. In essence, the independents created value where their larger counterparts saw little.

So the decision by the majors to leave the friendly confines of America turned out to be a good decision for all concerned. However, as today’s oil and gas companies and their stakeholders bask in the glow of superheated commodity prices, it behooves us to ask what comes next. What’s to be done with all this cash?

For the past couple of years, share buybacks have been a popular choice for the giant oil companies and many independents as well, said Art Smith, chairman and CEO of John S. Herold Inc., an independent research firm specializing in the analysis of companies, transactions, and trends in the global energy industry.

Share repurchases among the Big 6 oil companies - BP, Chevron, ConocoPhillips, ExxonMobil, Shell, and Total - more than doubled each year from 2003 to 2005. As cash began building on their balance sheets, smaller companies such as Hess, PetroCanada, Marathon, Murphy, Norsk Hydro, and Suncor also have been gobbling up their own shares.

Many of them are being cautious, although the past several quarters would indicate that capital expenditures are on the rise as E&P companies strive to increase, or at least replace, their reserves. Some are growing organically, through the drillbit, while others have increased their reserves dramatically through acquisition.

Still, many energy companies are accumulating significant amounts of cash. As a result, some of them are looking hungrily at other firms that would complement their existing portfolios.

Burlington Resources deal

One recently completed transaction is ConocoPhillips’ acquisition of Burlington Resources, the tenth-largest US oil and gas company and a significant producer of natural gas in North America, for roughly $35.6 billion. The deal, which closed on March 30, illustrates the impact the surge in price and demand for natural gas is having on the industry.

The purchase elevates Houston-based ConocoPhillips to the No. 2 position among domestic producers in the US in terms of assets, ahead of Chevron Corp., according to Marilyn Radler, senior editor-economics for Oil & Gas Journal. At the end of the first quarter of this year, ConocoPhillips’ assets totaled $160 billion, while Chevron had about $128 billion in assets.

For the first quarter of 2006, ConocoPhillips was the fastest-growing company in the OGJ200, said Radler. The firm’s stockholder equity grew 37% during the quarter, and its net income increased 13% from a year earlier.

ConocoPhillips chairman and CEO Jim Mulva said the deal enables his company to expand its high-quality, low-risk, long-life gas reserves in North America. “Overall, our North American gas supply position is strengthened both in the near term, through projects involving conventional and unconventional resources, and in the long term through LNG and Arctic gas projects.”

He added, “We anticipate immediate and future cash generation from this transaction that will aid in the reduction of debt incurred for the acquisition and go toward the redeployment of cash into strategic areas of growth. ConocoPhillips also has gained well-recognized technical expertise that, together with our existing upstream capabilities, will create a superior organization to capitalize on the expanded asset base.”

Mulva noted that Burlington Resources, also a Houston-based firm, was “an excellent complement” to the oil and gas portfolio of ConocoPhillips.

Under terms of the deal, ConocoPhillips shareholders own about 83% of the company after the transaction, and Burlington Resources shareholders get about 17%.

Is the integration of Burlington Resources’ assets into ConocoPhillips a sign of things to come in the upstream sector? Can we look for more M&As involving the super majors and some of the larger independents in North America? Let’s examine several other recent transactions and consider the implications.

“ConocoPhillips has gained well-recognized technical expertise that, together with our existing upstream capabilities, will create a superior organization to capitalize on the expanded asset base.” - Jim Mulva, chairman and CEO, ConocoPhillips (speaking about the Burlington Resources acquisition)

Chevron’s recent activity

Perhaps it’s instructive to look at Chevron’s activity. Last August, Chevron completed a tortuous four-month takeover of Unocal Corp. that involved a competing bid from China National Offshore Oil Corp. (CNOOC), which appeared to be interested primarily in Unocal’s oil reserves in Southeast Asia.

With the aid of allies in Washington, Chevron was able to convince CNOOC, which is partially owned by the Chinese government, to withdraw its bid, although some of the rhetoric about foreign ownership of US energy companies being a threat to US security may have strained relations between Washington and Beijing.

After the rival bid was withdrawn, Unocal shareholders met and overwhelmingly approved the $18 billion takeover by Chevron. For Unocal, based in El Segundo, Calif., the merger meant the end of the company’s 115-year history of independence.

Chevron chairman and CEO David O’Reilly commented, “The addition of Unocal strengthens our position as a global energy leader, and together we will be able to accomplish great results.”

O’Reilly added, “Unocal is an excellent strategic fit with Chevron’s assets and corporate culture. Chevron has proven technical and financial capabilities to maximize the full value of Unocal’s world-class assets, and Unocal’s talented employees worldwide will enhance our organizational capability.”

Following the merger, Chevron, headquartered in San Ramon, Calif., increased its payroll from roughly 47,000 employees to about 53,000, as more than 95% of Unocal personnel accepted positions with Chevron. Equally important to the expertise the company acquired is the estimated 15% increase in proved reserves, mostly in Southeast Asia, the Caspian Sea, and the Gulf of Mexico.

This past March, Chevron executives outlined a 5-year growth plan, which included innovations to enhance oil recovery in its existing properties and commercializing its natural gas resource base. O’Reilly pointed out that the company has tripled in size since 1998 and become more geographically balanced. At that time, nearly half of the company’s production was in North America. Today, it is less than 30%, with about 25% in the Asia-Pacific region.

Interestingly, only one of Chevron’s five major capital projects are in North America, and that is the deepwater Gulf of Mexico. The other four are offshore Angola, offshore Australia, offshore Nigeria, and Kazakhstan.

However, Chevron also announced it March that it is strengthening its position in the Canadian oil sands. The company recently acquired 5 heavy oil leases in the Athabasca region of northern Alberta that comprise about 75,000 acres and have an estimated 7.5 billion barrels of oil in place. Chevron previously acquired a 20% stake as a joint venture participant in the Athabasca Oil Sands Project. Since opening in 2003, AOSP has produced more than 100 million barrels of bitumen.

Chevron Calgary Limited, the Calgary-based subsidiary of Chevron, has been active in Canada since 1938, and it would not be unexpected to see the company acquire additional acreage in the oil sands and the companies that are operating there.

Although Chevron has said it plans to expand its refinery at Pascagoula, Miss., to become the second largest in the US, no major domestic upstream projects, except for the deepwater Gulf, or acquisition targets have been discussed publicly.

“The addition of Unocal strengthens our position as a global energy leader, and together we will be able to accomplish great results.” - David O’Reilly, chairman and CEO, Chevron Corp.

ExxonMobil

With $216 billion in assets, Exxon Mobil Corp. has its fingers in quite a few pies. As the largest US-based oil and gas company, ExxonMobil was a global player in countries most of its competitors couldn’t locate on a map. As a result, the huge vertically integrated company continues to sit stalwartly atop the energy food chain secure in knowing that it is a global leader in all of the industry segments in which it operates - from exploration and production to retail marketing and everything in between.

That said, no company in any industry can afford to rest on its accomplishments for long. Although the Irving, Tex.-based firm touts its overseas ventures in places like Qatar, Abu Dhabi, Russia, Angola, West Africa, Libya, Indonesia, Australia, and Norway the loudest, it remains active in North America as well.

Unknown to many, ExxonMobil is the largest crude oil producer in Canada, as well as a leading natural gas producer. It holds the largest resource position in Canada through its wholly-owned affiliate, ExxonMobil Canada, and its majority-owned affiliate, Imperial Oil (ExxonMobil interest is 69.6%).

In May 2004, EM and Houston-based Apache Corp. began a program of transfers and joint venture activity aimed at increasing the value of their respective portfolios across a broad range of prospective and mature properties. These properties are located in West Texas, onshore Louisiana, and the Gulf of Mexico continental shelf, as well as western Canada.

Under that agreement, ExxonMobil gained deep gas rights to certain Apache properties in the Gulf of Mexico and onshore Louisiana, while Apache gained access to EM properties in western Canada and the Permian basin of West Texas and New Mexico.

In May 2005, the two companies expanded the agreement in the western Canada province of Alberta. ExxonMobil Canada Energy has farmed out its interest in about 650,000 acres of additional undeveloped property interests to Apache Canada Ltd. over and above the 370,000 acres conveyed in 2004. Under the expanded agreement, Apache has agreed to drill and operate 145 new wells in both shallow and deep zones over a 36-month period with upside potential for further drilling.

Apache CEO Steven Farris noted that the expanded relationship with ExxonMobil allows Apache to add almost 800,000 acres to the company’s existing 6.9 million acres on which to explore in one of the most prolific natural gas basins in North America.

“For ExxonMobil, it assures that a significant amount of its acreage will be evaluated with the drill bit,” added Farris.

With the retirement of longtime ExxonMobil chairman and CEO Lee Raymond on Dec. 31, 2004, it remains to be seen whether his successor, Rex Tillerson, will lead the company in a slightly different direction or stay the course.

Raymond made the bold move in 1998 to merge Mobil Oil Corp. into Exxon, creating the largest privately-owned (not state-owned) oil company in the world at a time when oil prices were low and the synergies created from the merger allowed the combined companies to be more competitive against larger national oil companies (NOCs) and international oil companies (IOCs) and to take on bigger long-term projects.

However, EM has not made a major acquisition in the intervening years, and it will be interesting to see if Tillerson will seek to expand agreements such as the one he has with Apache by making a bid for that company or other similar large independents. It is well known that corporations often choose to gain expertise by acquiring other companies that already possess that expertise.

Candidates for acquisition

So, if the super majors are preparing for a return to the US upstream sector, which of them would be good candidates for acquisition? Obviously it would be ones that have demonstrated expertise in developing the kind of reserves the potential acquirer would need to keep Wall Street and their shareholders happy.

Burlington Resources has already been gobbled up. Other companies that might appear to be attractive takeover targets might include Devon Energy, Anadarko Petroleum, Apache, Chesapeake Energy, XTO Energy, Noble Energy, EOG Resources, Pioneer Natural Resources, Pogo Producing Co., Plains Exploration & Production, Southwestern Energy, and Denbury Resources - just to name a few.

Based on recent financial performance, including up to 400% growth in earnings by some of them in the last quarter, these large independents would fetch a high price in the M&A marketplace.

Each of them has grown and prospered in the years since the majors left them and other independents to produce more than 90% of US oil and gas production. Chalk some of their success up to high commodity prices, but that alone doesn’t assure profitability. Good management and experienced oil and gas professionals, some of whom started their careers with the majors, are the reason the companies grew and prospered.

In this day and age when recruiting and retaining qualified professionals at all levels is crucial to a company’s success, acquiring an organization with these human assets is a no-brainer.

The Exxons, Conocos, and Chevrons may argue that they never left the US. They may be right on a technicality because they did keep a presence. But it is clear that hundreds of independent producers and operators moved in to fill the vacuum created when these global oil and gas giants walked away from millions of acres of assets in the Rockies, Mid-Continent, Appalachian basin, Permian basin, and Gulf Coast regions of the country.

Reason to return

Mark Tuckwood, an upstream analyst with Wood Mackenzie, believes he knows why the majors may be considering a return to the US.

“All the majors are facing the same problems in terms of replacing reserves,” said Tuckwood. “It is becoming harder and harder. That’s why they are now looking at tight gas, shale, and oil sands. When they left, it wasn’t high impact enough for them. With $70 oil and $7 gas, the economics have changed. Now it is worthwhile for them to return.”

A secondary factor in any decision to return to the US may be global politics and security concerns in certain overseas locations, Tuckwood said. “While it’s certainly not the driver, geopolitics may enter into the equation for some companies.”

Kidnappings from offshore installations in Nigeria, terrorist activity in parts of the Middle East, and increasingly hostile governments in Venezuela, Bolivia, and Ecuador may make some of the super majors nostalgic for the relative calm and stability in the US and Canada.

“When [the super majors] left, the unconventional plays were in an embryonic stage,” added Tuckwood. “During the intervening years, the independents have proved these formations can be exploited successfully. There is much less risk today so long as prices don’t collapse.”

In short, conditions have never been better for ExxonMobil, ConocoPhillips, and Chevron to return to America. And, if they do, the super majors are likely to become super predatory.

“All the majors are facing the same problems in terms of replacing reserves. It is becoming harder and harder. That’s why they are now looking at tight gas, shale, and oil sands. When they left, it wasn’t high impact enough for them. With $70 oil and $7 gas, the economics have changed.” - Mark Tuckwood, Wood Mackenzie upstream analyst

BP plans to invest $37 billion in US

AInternational super major BP plans to invest about $37 billion in the United States to explore, produce, and process more oil and natural gas, according to the company’s chairman and CEO, John Browne. The remarks were made during a speech by Browne at the National Press Club in Washington, DC.

BP will spend $16 billion in the next decade on oil and gas exploration and production in the deepwater Gulf of Mexico, said Browne. The company also plans to spend $17 billion over the same time frame on US onshore oil and gas development in the Rocky Mountains and other producing regions.

In addition, Browne said that BP will invest approximately $3 billion in refinery upgrades to process more Canadian heavy oil, which is becoming more common in US crude markets as supplies of light crude are depleted.