Merger Mania Paves The Way For A New Era In U.S. Shale

Mergers and acquisitions are how an industry normally handles tough times. Asset prices drop, some companies can no longer survive on their own and become targets for those with the means to grow through takeovers.

The latest crisis, however, was different. The M&A wave started slowly, because a year ago, many people doubted that the oil and gas industry would be able to recover from the twin blows of the pandemic and the energy transition drive it spurred. Yet when it began, the wave carried several huge deals. The interesting thing about these deals was that almost none of them involved the vertically integrated supermajors as buyers.

The Financial Times' Justin Jacobs referred to these new pandemic-inspired majors in the U.S. shale patch as "super independents." In a recent article, Jacobs noted that deals worth more than $30 billion were completed in the second quarter of the year alone, adding that investor pressure would likely lead to more mergers and acquisitions in this space.

The reasons for the pressure are three-fold, according to Jacobs. Firstly, the fewer shale producers there are, the easier it is to keep production growth under control in case prices retreat. Secondly, we have the already familiar thirst for greater shareholder returns. Thirdly, having fewer larger shale oil and gas players would render them less vulnerable to mounting environmental pressure from various stakeholders.

Ultimately, however, it's a question of survival. The latest M&A wave in U.S. oil and gas may have started late, but it surely gathered pace quickly, especially when shale drillers, even some big ones, started going under, revealing the weaknesses of an industry that had been burning cash for years, subsisting on debt, and boosting production to pay off these debts. It was a vicious circle that could only take U.S. shale drillers that far.

"We have way too many players in the sector that are way too undercapitalised and too small to drive the efficiencies and returns that investors need, so we will continue to see consolidation happen," Citi energy banker Stephen Trauber told the FT's Jacobs.

According to him, companies with a market capitalization below $10 billion would find it hard to survive in today's energy industry, and there are only a few companies with that kind of market cap in U.S. shale right now.

There may be even fewer going forward because the consolidation drive is not over yet.

"Three of the last four quarters have been extremely active going back to 3Q 2020," Andrew Dittmar, senior M&A analyst at research and analytics firm Enverus, told Forbes' David Blackmon last month. "1Q 2021 was kind of quiet, but overall, we've had a little over $85 billion in US upstream M&A over the last 12 months. So we've been on a busy run of consolidation since the market began to re-emerge from COVID."

Earlier this year, Pioneer Natural Resources' chief executive, Scott Sheffield, said the shale industry needed further consolidation to get rid of the small independents that were the quickest to start adding rigs after prices began recovering.

"I hope other privates are taken out that are growing too much," Sheffield said, highlighting the growing divide between the biggest and the smallest in the business that turned the United States into the world's largest oil producer two years ago. Yet while this was probably a cause for pride in 2019, a year later, it became a problem.

When the coronavirus pandemic destroyed demand for oil with much of the world going into a lockdown, OPEC+—as well as a few other non-OPEC oil producers—agreed to put a cap on production to avoid a further slide in prices. The United States refused to impose production cuts, both on a federal government and on an industry level. The market, President Trump said at the time, will take care of production.

Indeed, the market did take care of production, eventually forcing U.S. producers to cut some 2 million barrels daily in total production. Much of these cuts came from the shale patch as small independents simply could no longer survive in the new price environment. Even back then, the large shale players warned against too much production, but for the small players, production was the only way to keep going in the vicious circle of debt-production-debt repayment.

The truth is that the more players there are in a market, the more difficult it is to control the direction the market takes. This is true for any industry, and oil and gas are no exception. So, the buying spree that large U.S. independents seem to be on has another explanation besides the synergies touted with each merger, the environmental pressure the industry is feeling sharply, and the other shareholder demands.

The truth is that the bigger piece you have of a market, the bigger say you get in pushing this market in a direction you want to see it move in. The fewer players in shale oil there are, therefore, the easier it will be to control it.