Why is Energy M&A Plunging?

Mergers and acquisitions in the energy industry continue to plunge. Here’s one reason why that might be the case.

Apr 9, 2014 at 10:22AM

Devon Energy Hornriver Ca

Photo credit: Devon Energy. 

Oil and gas companies spent just $33.4 billion on mergers and acquisitions in the first quarter. While that might sound like a lot of money, it's actually 28% lower than the average quarterly M&A activity over the past three years. Overall deal volume is also 27% lower. Let's take a quick look at some of the recent deals and then consider why activity might be slowing.

Notable deals
There were only two big deals of note in North America last quarter. Devon Energy (NYSE:DVN) sold its Canadian conventional assets to Canadian Natural Resources (NYSE:CNQ) for C$3.125 billion. Separately, Energy XXI (NASDAQ:EXXI) agree to acquire EPL Oil & Gas (NYSE:EPL) for about $2.3 billion. Other than that, the quarter saw only a sprinkling of small bolt-on acquisitions.

Investors had expected the Devon Energy deal as the company recently spent $6 billion to acquire a position in the Eagle Ford shale. Devon had said it would sell some of its Canadian assets, as well as some of its U.S. non-core resources, to help to pay for the Eagle Ford deal. Canadian Natural Resources paid a nice premium for the complete package of Devon's Canadian assets. It's a deal that makes strategic sense for both companies.

Energy XXI's deal to acquire EPL Oil & Gas also makes strategic sense. It will grow Energy XXI's scale in the Gulf of Mexico, add a number of visible growth assets, and be highly accretive to earnings. Furthermore, as the following slide shows, EPL's assets really fit in with those owned by Energy XXI.

Energy Xxi Epl Merger

Source: Energy XXI Investor Presentation (Link opens a PDF). 

What, no shale?
What's interesting about these two deals is both involved conventional oil and gas assets, not shale assets. Outside of a few deals by the former CEOs of early shale leaders, it was a largely quiet quarter in America's shale plays. That's a big shift from recent M&A activity in the energy sector, which has focused around shale resources. Is this just a lull in the market or a sign of things to come?

 Oil And Gas Stocks To Buy Now Devon Energy

Photo credit: Devon Energy 

We're seeing a lull while companies decide which direction to grow in the future. This is happening not only in the acquisition market, but in capital spending, too. For example, there has been quite a pullback in the offshore drilling segment -- energy companies aren't committing to signing new contracts for offshore drilling rigs. One reason for that is because Big Oil is drowning in expensive projects due to capital spending that has gotten out of control. Big Oil also has had a problem making money from shale because it can't match the cost advantage of smaller rivals.

This has taken Big Oil largely out of the acquisition market. Instead, we're likely to see the oil majors unload assets in order to clean up bloated portfolios. There aren't as many buyers at the moment, as most shale-focused energy companies have enough drilling inventory to keep busy for a decade or more. In fact, that inventory continues to grow due to down-spacing and the discovery of additional layers of hydrocarbons.

Investor takeaway
It doesn't appear that the industry is ripe for an uptick in merger and acquisition activity anytime soon. Big Oil has turned its focus to actually making money, while most shale-focused players already have plenty of growth opportunities. Unless someone starts a consolidation wave, don't look for much M&A excitement coming out of the energy patch in the near future.

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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