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Why This Deal Is a Win for C&J Energy Services

C&J Energy Services (NYSE: CJES  ) recently announced that it would be acquiring Nabors Industries' (NYSE: NBR  ) completion and production businesses for $2.9 billion. Under the deal, C&J Energy will pay $937 million in cash and 62.5 million shares of the newly merged company, which will be headquarter in Bermuda and trade under the existing ticker, CJES. Existing C&J shareholders will convert their shares to those of the new entity on a 1 to 1 basis, tax free.

Besides the attractive incentives thrown into the Nabors deal such as tax exemptions derived from setting base in Bermuda, the deal presents a great opportunity for existing C&J Energy investors. This is not only because it allows C&J Energy Services to combine operations with Nabors while maintaining minimal overlap, but it also puts the new entity in a position to capitalize more effectively on favorable market developments, both locally and internationally.

Increased local demand for fracking equipment
The U.S. surpassed Saudi Arabia and Russia to become the world's largest producer of oil after output for the first six months of the year went above 11 million barrels per day, according to the International Energy Agency (IEA). The IEA further added that the US's new-found lead could stretch out through 2030 due to increased output in shale plays such as the Bakken and Eagle Ford.

In light of this new development, the next goal on the agenda for the US will be to maintain its top position. To achieve this, producers in shale plays will need to invest more in fracking equipment and services.

Another driver for increased investments in fracking equipment is the possible exportation of surplus US natural gas to Europe. Ever since the situation in Ukraine imploded, Europe's energy reliance on Russia has seen Russia arm-twist it into unfavorable political positions through threats of cutting gas supply.

Fracking opposition
Although Europe has revisited the previously unsuccessful fracking debate as a means of countering Russia's energy dominance and the resultant influence it gives the former communist nation, the reality is that fracking may take a while due to several impediments, including resistance from the citizenry and possible failure to get commercially viable deposits.

Even in the U.S., where fracking has succeeded tremendously, opposition has been stiff, as signaled by a recent move by the city of Denton, Texas to put a ban of fracking in the area up for public vote in November. It is thereby likely that Europe will attempt to placate the US into exporting its surplus natural gas, at least before its (Europe) fracking ambitions materialize. Consequently, the accelerated push by several European nations and a contingent of U.S lawmakers to expedite the approval of export terminals in the U.S still persists. 

The U.S.'s need to maintain top producer position, as well as its ability to use its energy dominance to strengthen ties with allied European states through possible gas exports, will stir increased crude and gas production. Naturally, suppliers of fracking equipment will swamp the market (as they already have) to capture increased fracking demand, leading to a general decline in prices of fracking equipment and services.

C&J Energy's new deal has however allowed it to more than double in size, giving it sufficient scale to enjoy higher-cost benefits and thereby price more competitively. This scale should be instrumental in countering the low prices induced by increased competition, effectively allowing it to record higher sales in the face of competition.

Tapping international networks
C&J Energy's merger with Nabors also gives it access to the latter's pervasive international networks, which span across The Middle East, the Americas, Africa, and the Far East.

Escalating turmoil in the Middle East has slowed output in recent months. Considering the feverish pace at which violence instigated by the jihadist group ISIS is picking up in Iraq, it is likely that output from the region will slow down considerably this year, and probably the next. This might considerably disrupt global oil supply, considering Iraq is the second biggest OPEC producer. Similarly, instability and oil theft have also reduced output from Libya and Nigeria, respectively.

The overall effect is that international output may decline, prompting the few producers in the Middle East who are experiencing relative calm at the moment to take on more exploration and production in order to offset the overall supply deficit. Accordingly, E&P spending in the Middle East is expected to increase 14% during the year, as represented in industry commentary by James West, managing director at Barclays Capital. The increase in E&P spending in the Middle East will be higher than the U.S's expected 8.5% uptick and the projected global average of a 7% increase in spending for this year.

Bottom line
As international producers look to spend more in order to add capacity and offset the deficit induced by insurgency in the Middle East, international prices of exploration and production equipment and services will increase, allowing C&J Energy, through Nabors, to capitalize on the opportunity. This new exposure to the international market essentially allows C&J Energy to complement the valleys and peaks in the US business, and vice versa. In consideration of this, investors should expect sustainable growth from C&J Energy going forward.

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Lennox Yieke

Lennox Yieke is a business writer who has a knack for not only seeing first what others see eventually, but telling the story from an entirely fresh, interesting, informed and ‘Foolish’ perspective. Join him as he covers energy, materials and utility stocks, breaking down mind-boggling numbers and loads of jargon into tidbits of understandable, valuable investing guidance. Always feel free to engage with him and share your latest ideas on Twitter @lyieke

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Related Tickers

9/3/2015 4:02 PM
CJES $5.20 Up +0.27 +5.48%
C&J Energy Service… CAPS Rating: ****
NBR $10.74 Up +0.12 +1.13%
Nabors Industries… CAPS Rating: ***