The American shale boom caught Big Oil with its pants down. As each of the integrated majors looked for oil in far-off corners of the globe, a small handful of prospectors unlocked billions of barrels of oil and natural gas equivalent right under Big Oil's nose. That's not a metaphor -- a large shale gas formation is right under the foundation of ExxonMobil's (NYSE:XOM) headquarters in Irving, Texas.
Independent oil producers and analysts have had a laugh at these major oil companies trying to get into the shale game, mostly because they have failed to replicate the smaller players' success. However, with oil prices slumping in recent months to almost half of the per-barrel price that had held relatively steady for three years, now might be the time for Big Oil to laugh... and make a big push into the shale game. Let's look at why the ExxonMobils and Chevrons (NYSE:CVX) of the world might want to shop for new production in the U.S.
Shale ain't the same game anymore
I think we can all acknowledge that many integrated majors' attempts to enter the shale business did not work out like they hoped. Since a number of them were late to the game, they were either stuck with crappy acreage positions outside the heart of a shale formation, or they paid so much for some of that prime acreage that the economics didn't work out that well. This is a large reason why Royal Dutch Shell (NYSE:RDS-B) has sought to divest nearly all of its exposure to shale.
What made it even harder for Big Oil -- and to a lesser degree everyone else in the game -- was that the techniques for hydraulic fracturing shale were still being developed . Many of the revelations that companies have had over the past few years -- Wait, if I put more sand down a well, that will hold open the fractures in the rock better? Go figure -- had not yet been discovered, which affected the economics of these projects.
However, major advancements in the cost of shale development have significantly improved the economics for certain shale wells. Some of the best wells in certain shale basins can break even -- which is actually a 20% return on the well -- at as little as $30 per barrel.
Big Oil positioned to pounce
Among the main advantages the integrated majors have over smaller players in the space are the economics of scale and balance sheets that resemble an impenetrable fortress. Unlike many of the independents drilling shale wells in the U.S., which have junk bond status and are becoming less able to take on new debt, Big Oil could easily absorb that debt and roll it over into their better than credit-grade ratings without batting an eye. Also, based on the current ratio for some of these companies, it appears they all have some excess working capital on the books that could be used in an acquisition (a current ratio greater than one means a company has more liquid assets on the books to cover current liabilities).
|Company||Debt-to-capital ratio||S&P Credit Rating||Current Ratio|
|Royal Dutch Shell||18.4%||AA||1.2|
Also, now could be an opportune time for these companies to make some acquisitions because several of their long-term capital projects are starting to come online, so total capital expenditures are diminishing.
Shale is on sale!
One of the biggest problems investors have with acquisitions is that most executives are horrible at timing the purchase. For some reason, big buys all seem to happen at the top of a commodity cycle, so the purchaser pays a premium -- I'm looking at you, ExxonMobil, for that XTO Energy buy in 2010.
Today, though, that isn't as much the case. With oil prices deeply depressed, many investors have run away screaming from energy stocks. This has left many companies in U.S. shale space much cheaper than they were less than a year ago.
|Company||Enterprise Value/EBITDA||Price/Tangible Book Value||Price/10% discounted future cash flows (PV-10)|
This is just a small sample of the many companies in the space, but it gives you an idea of the potential acquisition discounts available these days.
What a Fool believes
I can understand that ExxonMobil, Shell, and their peers might be feeling once bitten, twice shy about getting involved in shale after the original experiment, but when the stars align, it can be worth taking a second look at anything. Drilling shale today might not be the most lucrative endeavor, but these Big Oil players have the luxury of sitting on prospective oil and gas formations for years before the economics are right. Heck, ExxonMobil just brought a project online it started back in the 1980s.
With the security of rock-solid balance sheets, hefty stashes of cash that are expected to grow in the next few years, and a potential source of new production that is trading at a steep discount to the value of what's in the ground, it appears the time is right for Big Oil to do some wheeling and dealing in the North American shale game. Don't be surprised to see some activity in this space in the near future.