Are there mergers afoot in the oil/gas industry?

Autor: Article based upon analysis from Reuters Breakingviews | Link: Stingy investors make for dry M&A oil patch
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Often high stock prices encourage corporate chieftains to buy rivals. But both dollar value and the number of deals in the fossil fuel sector have dropped more than 10% so far this year compared to the same period in 2021, according to Refinitiv, making it the second worst year on record in a decade.

Occidental Petroleum and Hess are among the top performing stocks in the S&P 500 Index, yet deals are proving hard to come by. Oxy’s Chief Executive Vicki Hollub was the last bigwig to lunge for a deal, and she almost lost her job because she was considered too aggressive.

That’s due to some unique industry characteristics. But it also says a lot about the state of the fossil fuel business overall. Oil mergers are often more necessary when prices are falling. The most active year in recent history was 2014, when the price of a barrel of Brent crude crashed from $114 to $57 in a matter of six months. If each barrel of oil is bringing in less cash, cost-cutting through M&A will obviously make good business sense.

Conversely if oil prices are high, and all companies are doing relatively well, each stock price may be equally overinflated. While that hasn’t stopped executives from searching for deals, it hasn’t exactly been popular.

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More recently, investors have been urging oil companies to have a sharper focus on spending, and that means handing cash back. Investors have also successfully pressured corporate boards to align executive payout structures with return on investment rather than revenue growth.

Conversely, as fossil fuel companies come under pressure from environmental activists, funding is scarcer and more expensive. The weighted average cost of capital for integrated oil companies, near 7%, is two percentage points higher than other sectors, according to research from New York University. For longer-term projects, hurdle rates can be as high as 20%, according to Goldman Sachs, whereas renewable projects in Europe can be in the low single digits.

Oil prices have now fallen to around $80 a barrel, which could encourage more deals. This week some small deals have been announced, including EQT’s EQT.N $5 billion deal to buy THQ Appalachia. And as the big reset takes hold and the industry shrinks, companies are bound to merge. But that obscenely high hurdle rate is a new dynamic that will likely gum things up. For now, the deal well is running dry.

Foto credit: Institute for Mergers, Acquisitions and Alliances