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Declining returns on investment and rising capital spending are two factors that have been haunting international oil and gas players ExxonMobil (NYSE: XOM ) and Chevron (NYSE: CVX ) throughout much of 2013. However, their domestic counterparts, the likes of EOG Resources (NYSE: EOG ) and Cabot Oil & Gas (NYSE: COG ) , have not been forced to grapple with similar pressures.
Indeed, looking at the cash flow statement of Exxon for the first nine months of this year, we can see that the company spent nearly $28 billion on investing activities while only receiving around $35 billion in cash from operating activities. You may say, "well, that's still a $7 billion profit," however, when we consider the fact that Exxon spent an additional $21 billion buying back stock and paying dividends during this quarter, things look different. Meanwhile, Chevron spent $26 billion while only taking in $25 billion in cash.
On the other hand, EOG made a cash profit of nearly $500 million for the first nine months of 2013, and Cabot broke even. Also bear in mind that these smaller exploration and production companies don't offer much in the area of dividends and share repurchase commitments, so there is less pressure on cash flows.
Robust balance sheets
With cash flows under pressure, the market has started to speculate that international oil players may start buying up smaller peers, effectively skipping out on the speculative exploration stages, which can be costly.
Indeed, Exxon is no stranger to buying up smaller peers. The company is already the largest natural gas producer in the U.S. 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 company. For example, at the end of the third quarter, Exxon had net debt of around $16 billion, a debt-to-asset ratio of only 4.6%. Chevron, on the other hand, had a net cash balance of approximately zero, so both companies have plenty of room to borrow and buy up smaller peers -- some could argue that Chevron needs to borrow more to make use of low interest rates and gear-up while the going is good.
But which companies would provide suitable targets? EOG, mentioned above and the second-largest independent U.S. oil and gas producer by market value, would make a good candidate. EOG's production is accelerating rapidly, with year-on-year third quarter production up 9.6% to around 526,000 barrels per day in the third quarter. EOG is special as the company 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 $50 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 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 $17 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 an enterprise value-to-revenue figure of 10.4, 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 U.S. 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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