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Declining returns on investment and rising capital spending are two factors that have been haunting international oil and gas players such as ExxonMobil (NYSE: XOM ) and Chevron (NYSE: CVX ) during the past year or so. Indeed, looking at the cash flow statement of Exxon for the first half of this year, we can see that the company spent nearly $19 billion on investing activities, while only receiving around $21 billion in cash from operating activities.
Chevron spent $17 billion while only taking in $14 billion in cash. Meanwhile, smaller US producers are seeing much bigger returns on their investments. EOG Resources (NYSE: EOG ) for example spent $3 billion in capital expenditures and only took in $3 billion in cash receipts for the first half of the year; however, if we compare return on invested capital, EOG returned 2.3% for the second quarter, while Exxon's ROIC was 2%. This may not seem like a huge difference, but EOG's return is 15% higher than that of Exxon. On an annualized basis, EOG's ROIC will be 9.1% at current rates while Exxon's ROIC will be 8% at current rates. Chevron's annualized ROIC will be around 8.8% at current rates.
Robust balance sheets
These low levels of return have led to a lot of speculation that big international oil companies such as Exxon and Chevron will start to acquire their smaller, much more productive and efficient peers, which are focused on US oil production. It would appear that these rumors have some weight behind them. Indeed, with Exxon's oil production decreasing 1.9% year on year as of the second quarter, the company will soon be forced to start looking for additional growth elsewhere.
Exxon is no stranger to buying up smaller peers. The company is already the largest natural gas producer in the US after the $25 billion acquisition of XTO Energy in 2010. Exxon also spent $1.6 billion acquiring Denbury Resources' Bakken assets last year. But even these multi-billion dollar acquisitions are nothing but peanuts for the world's largest oil and gas company. At the end of the second quarter, Exxon had net debt of around $15 billion, a debt-to-asset ratio of only 4.3%. Chevron on the other hand had a net cash balance of nearly $2 billion so both companies have plenty of room to borrow and buy up smaller peers.
But which companies would provide suitable targets? EOG, mentioned above would make a good candidate. Already achieving a better return on capital than its larger peers, EOG is somewhat vertically integrated. The company has rail infrastructure, three sand mines and two sand processing plants, which it brought up to fulfill the company's annual demand for 3 million tons of sand per year, required for the company's fracking operations. According to EOG chairman, Mark Papa sourcing its own sand saves EOG $500,000 per well on average, around 7% of total well costs.
EOG has an enterprise value of $51.6 billion, so a buyout would cost Exxon or Chevron significantly more than this as they would be expected to buy EOG out for a premium. However, a deal of this size could prove too much for both oil majors as this acquisition would require a large amount of debt and significant regulatory hurdles to clear.
Elsewhere, Cabot Oil & Gas (NYSE: COG ) looks like an interesting opportunity. According to the company's president and CEO Dan O. Dinges, Cabot has the most economic natural gas production in North America, with a breakeven cost of below $1.20/Mcf. In addition, the company aims to increase production by 44%-54% for full-year fiscal 2013 and then increase production again by 30% to 50% during full-year fiscal 2014.
With an enterprise value of around $16.7 billion, half that of EOG, Cabot looks like an attractive prospect for the oil giants looking to absorb smaller competitors. That said, Cabot does look expensive when compared to peer EOG, as Cabot trades at a forward enterprise value-to-revenue figure of 9.3, triple EOG's ratio of 3.5.
All in all, falling investment returns, rising capital spending, and declining production are all factors hurting international oil and gas producers such as Exxon and Chevron. On the other hand, smaller US producers are still growing rapidly. With clean balance sheets and plenty of appetite for borrowing in the financial world, the world's largest oil and gas players could be about to embark on an acquisition spree and there are plenty of targets that could become prey.
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