It seems to me that there are two meaningful lessons to be gleaned from the energy sector this week. The first is that, just as a basic law of physics states that what goes up must come down, a tenet of market thermodynamics, if you will, says that what goes into private equity must eventually come back out. The second involves a conviction of mine that deal activity in the oil patch is likely to escalate significantly this year.
General Electric (NYSE:GE) started it off on Monday by announcing it will acquire Vetco Gray, a Houston-based supplier of equipment for onshore and offshore oil and gas fields. This includes equipment for sub-sea applications. Vetco is now owned by private equity firms Candover Partners, 3i Group, and JP Morgan Partners. GE apparently will pay the partners $1.9 billion for Vetco, which they acquired in 2004 for $925 million.
Vetco is expected to generate about $1.6 billion in revenues for 2006. The ongoing exploratory movement into deeper waters is likely to continue to benefit the sales of its sub-sea equipment, a market also served by such other public companies as Cooper Cameron (NYSE:CAM), FMC (NYSE:FMC), and Dril-Quip (NYSE:DRQ).
The sector's other noteworthy deal announcement Monday involved Denver-based producer Forest Oil (NYSE:FST) buying Houston Exploration (NYSE:THX) for total compensation of about $1.6 billion. In return, Forrest will gain increased exposure to North American gas sand basins, which benefit from the use of advanced drilling technology.
GE's acquisition of Vetco, in addition to proving that private equity transactions are but one aspect of a cycle that takes companies from the public arena to private ownership and back again, will increase the giant conglomerate's energy revenues by about 40%. It's also conceivable it could represent an emerging trend, wherein -- given the long-term attractiveness of energy -- large industrial companies acquire positions in the energy services industry. Heretofore, most oil and gas service companies have been standalone entities, but in the final analysis they simply perform specialized industrial functions, and could contribute meaningfully to more diversified industrial concerns -- like GE.
The Forrest acquisition indicates, I believe, that with energy commodities prices moving higher -- and despite the recent pullback, Goldman Sachs is still predicting an average 2007 crude price near $70, or about 25% above the current level -- exploration and production companies will attempt to position themselves to ramp up production and take advantage of the price changes. It's always faster and frequently cheaper to do this through acquisition than by turning a drill bit to the right. Thus, I think you'll see the rate of energy deals escalate this year from the 2,678 such transactions that Thompson Financial has counted for 2006.
If this prognostication is correct, in concert with the longer-term bullish trends for energy I've discussed in the recent past, it would seem that the energy sector deserves the careful attention of Foolish investors in 2007.
For related Foolishness:
- An Energy Services Starter Kit
- A Promising Energy Prospect
- The Best Small Cap for 2007: Dawson Geophysical
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Fool contributor David Lee Smith has watched the ups and downs of the energy sector for several years. He does not own shares in any of the companies mentioned and welcomes your comments or questions. The Fool has a disclosure policy.
