With oil prices having plunged during the pandemic, spiked hard after Russia's invasion of Ukraine, and then fallen again as the Federal Reserve raised interest rates, the oil and gas industry has seen its fair share of volatility in recent years. Oh, and the rise of electric vehicles makes the terminal value of many oil fields a looming question.
So it's no surprise to see subscale oil and gas companies look to sell these days, while larger players look to bulk up, diversify, and cut costs from merger synergies.
Over the weekend, it was reported that oil giant ExxonMobil (XOM 1.50%) is in talks to potentially acquire shale pure play Pioneer Natural Resources (PXD).
But would this be a good move for Exxon, which overpaid dearly for shale gas player XTO Energy back in 2009?
Why Exxon is interested: deep low-cost inventory in the Midland
The first thing to note about Pioneer is that it's a pure play in the Midland Basin of the Permian shale formation in West Texas.
Unlike a lot of other players that have diversified operations across different U.S. basins or between the U.S. and overseas, Pioneer decided to concentrate its portfolio in this single basin, where it has a deep inventory of some of the lowest-cost production in the U.S. shale patch. And because so much of its acreage is contiguous, that further reduces Pioneer's logistics costs and improves efficiency even more.
The result is that Pioneer has some of the highest-profit wells in the U.S., with the deepest inventory as well:
Image source: Pioneer Natural Resources.
Last year, Pioneer produced the second most barrels of oil in the Permian, behind only Occidental Petroleum (OXY 0.88%).
While ExxonMobil itself is no slouch in the region, with the fourth largest Permian production last year, Exxon's Permian production is still relatively small relative to Exxon itself. Last quarter, Exxon generated less a third of its liquids production and upstream profits from the United States.
With overseas production often in conventional oil formations that require lots of upfront investment, it's quite possible Exxon feels it needs more exposure to shale production. Unconventional shale production tends to be relatively capital-light, and with a much quicker payback than conventional oil projects.
Exxon's penchant for large, risky projects has been a mixed bag of late. In fact, Exxon just abandoned a large exploration project off the coast of Brazil, costing the company billions. On the other hand, Exxon's project off the coast of Guyana has been a smashing success, with Exxon discovering more than 11 billion barrels of oil in its Guyana properties thus far.
Given the quicker payback, shale inventory is good for when prices spike up, as these projects can be turned on relatively quickly. And because Pioneer has all of this proven inventory, the addition would be relatively low-risk for Exxon, as opposed to these "home run or strikeout" investments in offshore exploration.
Image source: Getty Images.
But risks remain if Exxon does acquire Pioneer
While an acquisition of Pioneer may be highly desirable for all the preceding reasons, it's also possible Exxon may be walking into another XTO Energy.
To summarize, Exxon bought XTO Energy, a leader in U.S. natural gas drilling, back in 2009. At that time, Henry Hub natural gas prices were about $5.00 per MMBtu, having fallen from $13.00 per MMBtu before the Great Recession hit.
Sounds good, right? Well, no, because improvements in fracking technology allowed competition to ramp up, causing natural gas prices to fall below $5 for basically the entire time since, with the exception of last year's six-month spike following Russia's invasion of Ukraine. However, natural gas prices have quickly corrected since September, reaching an average price of $2.31 per MMBtu in March.
Since oil prices have come down from their highs last June of about $120 to just under $80 per barrel today, it may also seem like an opportune time for Exxon to scoop up a shale oil producer like Pioneer. Yet could oil prices fall further and faster than many think? That could happen for any number of reasons, including a quicker adoption of electric vehicles or a demand-sapping recession.
In addition, a new concern has emerged in the shale patch: declining productivity from the best wells. Late last year and into this year, various shale players have reported lower efficiency in the Permian, with many producers missing production targets.
While the average well is still producing in-line with expectations, the very best wells in the basin have seen significant declines in output. The current narrative is that most of the sweetest spots, or "gushers," have been picked over already over the past 10 years, when fracking technology first opened opportunities in U.S. shale. So Exxon may be looking to buy into the Permian just as the region is seeing its productivity peak. That being said, there still remains a significant portion of the Permian that hasn't yet been explored.
What price will Exxon pay?
Of course, any acquisition could be good or bad depending on the price paid relative to the assets, and it's an open question as to how much Exxon might pay for Pioneer. Pioneer will probably demand a decent premium though, since the stock is sitting 27% below its all-time high reached last summer.
On the other hand, Exxon currently trades about 12% higher than Pioneer on a forward enterprise value-to-EBITDA basis. So Exxon could use some of its "expensive" stock to pay for a "cheaper" asset. It's also possible for Exxon to purchase Pioneer for cash. Pioneer currently has a $51 billion market cap, and Exxon earned $55.7 billion in net income last year alone, making an all-cash deal also possible.
While a deal may not happen, if it does go through, it would certainly be a blockbuster in the industry, giving Exxon a much bigger footprint in the U.S. after years of looking for growth overseas. Whether it's a good idea depends on the price paid and just how productive those Pioneer wells will continue to be, which is subject to some debate.
