The Permian M&A Heats Up - and How You Could Profit

The Permian M&A Heats Up – and How You Could Profit

by | published April 24th, 2019

The Permian Basin straddles the border area between West Texas and Eastern New Mexico. It is comprised of three primary production basins – in order of size, Midland, Delaware, and the Marfa.

It is also the focus of an intense amount of merger and acquisition (M&A) talk surrounding an increasing number of crude oil and natural gas producing companies.

For good reason.

The Permian is a prolific extraction area, currently the third largest oil basin in the world by production volume. It is the heir apparent in U.S. oil and – along with some assistance from the Eagle Ford in South Texas and others – certain to fuel an increase in American exports to higher-priced foreign markets.

As I have discussed in the past, moving substantially more Permian volume into either the domestic market or export is constrained by pipeline and port infrastructure limitations. Both of these are being addressed, as is the lifting of more associated natural gas existing along with crude oil.

This confluence of factors has begun to reduce the price of Permian oil.

Such a discount to the market price is an inevitable result of supply caught in a network of pipeline bottlenecks. This hits operators more forcefully, since they receive a wellhead price. This is the charge for the first arms-length transfer of product between producer and distributor, also at discount to the market price.

Nonetheless, the current environment is far more favorable than the last time an M&A wave hit…

What’s Driving Oil M&A

Even with the discounts, companies can still make a profit when WTI (West Texas Intermediate, the benchmark standard for New York-cut crude oil futures contracts) is above $66 a barrel.

Leverage provided by the rising price has allowed operators to balance production with keeping an increasingly valuable asset in the ground for later lifting.

Operating costs, on the other hand, are also rising.

Well management and efficiency remain the most important management considerations. This results in a move to consolidate production, utilizing common field infrastructure and feeder pipes.

This is always a driver for M&A in the oil sector.

Especially when you consider that, even in situations were the price is strong, most producers remain “cash poor.” This means the next cycle of production is usually financed through debt, not revenue from prior sales.

Banks assess risk when providing oil companies with loans. While some smaller outfits these days remain vulnerable because of their heavy debt loads, most today have credit available at affordable rates. The known quantity of extractable oil and the price it commands allows lenders to assess lower debt costs.

But this is usually still the highest level of high-risk loans. In the parlance, most oil field development is met through debt not considered investment quality, in other words, junk bonds.

That fundamentally distinguishes what exists presently from what happened last time M&A heated up in the oil patch.

At that time, the market price for crude was collapsing. Following an OPEC decision to defend market share rather than price, WTI went from more than $100 to below $30 a barrel.

Many U.S. companies found themselves between the proverbial rock and hard place. Almost literally one step ahead of the sheriff, they were forced into a vicious spiral requiring continued production at a loss and then selling product for what they could get.

By the end of 2014, the cost of debt for these companies became in many cases impossible to sustain. The gulf between energy company debt and other high yield (the “junk” paper) products grew worse.

In my industry briefings through 2015 and into early 2016, I identified the last quarter of 2014 as the main problem that continued to rumble through the sector…

The Difference Between Then and Now

Two of my briefing slides at the time provide a very stark picture. The rate for high-yield energy company debt simply exploded.

Similarly, as availability and quality of energy credit collapsed, so did the value of publicly traded oil companies.

The M&A wave that resulted had all the earmarks of a fire sale.

However, the present situation is quite different.

The recovery in the market price for oil, combined with consolidations in ownership and advances in field practices, have resulted in a stronger sector. The companies that survived the last travail are better able to manage.

This is especially important for companies having traded stock. Equity value today is all about reserves, especially in a market witnessing rising prices. Share prices are not dictated by how much a company has sold, but by how much easily extractable reserves are on the company books.

M&A this time concerns absorption of known existing value in already producing wells, developed reservoirs, and operating field assets.

In short, the hunters are looking for stable, established, efficiently administered companies having oil resources in known locations.

This is very different from the causes of 2014-2016. It is also more closely following the M&A experienced elsewhere.

The picture intensified recently with Chevron acquiring Anadarko assets in the Permian. The big boys are focusing on the basin where massive amounts of oil have been produced and even greater amounts are known to exist.

My new Σ Algorithm has signaled seven companies in the Permian that are prime M&A targets. I have begun releasing them to my three investment services in a series of straight stock buys and options plays.

I fully expect to see some very nice profits coming out of these plays. If you’d like to join them, just click here.

The game is afoot!



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