• Tom Bradley

A Landmark Deal for the Oil & Gas Industry

Credit: Jan-Rule Smenes Reite:

US supermajor oil firm Chevron have agreed a $5bn all stock deal for Houston based Noble energy, making it the largest deal in the oil & gas industry since the outbreak of COVID-19. Chevron will take on Noble’s $8bn debt pile taking the enterprise value of the deal to $13bn, highlighting the strength of Chevron’s balance sheet amidst both a global pandemic and market turmoil in the energy industry with supply gluts fuelled by failures to make production cuts from OPEC states coinciding with reduced global demand as a result of the economic crisis caused by COVID-19.

Under the $5bn all-stock deal Noble’s shares are valued at a meagre $10.38, only a 7.6% premium to the closing share price on July 17th of $9.65 before the deal was announced and well below the $27 reached in 2019. This continues the trend of weak premiums for M&A deals in the sector with Callon Petroleum only paying a 6.7% premium for Carrizo Oil & Gas in 2019 and PDC Energy acquiring SRC Energy at a 3.8% discount also in 2019. Noble’s shareholders will receive 0.1191 shares in the merged firm for each share they currently hold in the smaller firm, however shareholders will likely feel Noble should have negotiated a higher price, especially considering they saw a market capitalisation of $9bn in the months prior to the pandemic. Moreover, Noble shareholders will own 3% of the combined company in spite of the expectation Noble’s assets will contribute 8% of the merged firms EBITDA, emphasising the value of the deal to Chevron. There are further lucrative financial benefits as a result of the acquisition – it is expected that the deal will bring $300m of savings through synergies as well as increasing Chevrons already enormous proven oil reserves of 11.4bn barrels by a further 18%.

The gains from this deal also make Chevron’s decision to pull out of a bidding war with rival Occidental Petroleum over the acquisition of Anadarko Petroleum appear to be a prophetical one. Occidental paid $56bn for Anadarko and have since struggled to cope with the heavy debt burden they acquired and there are now serious concerns mounting regarding the financial health of the merged firm. At first glance the Noble deal may appear to be a mere consolation to missing the bigger acquisition prize of Anadarko however it has enabled Chevron to maintain a healthy balance sheet alongside bringing important strategic benefits.

Permian basin, Texas. Source: Bloomberg

The acquisition has sound strategic rationale with Noble’s assets complementing Chevron’s existing positions. Chevron will increase their position in the US Shale industry with further expansion of their assets in the Texan Permian basin through Noble’s neighbouring 92,000 acre holding alongside the penetration of the Denver-Julesburg basin in Colorado they will gain. Arguably the most attractive asset Chevron will gain is Noble’s position in the Eastern Mediterranean through the Israeli Leviathan and Tamar gas fields.

These gas fields have been touted as Noble’s “crown jewel” due to their lucrative potential and offer crucial diversification for Chevron in a very geopolitically sensitive market. Chevron will also gain further offshore assets through a Noble position in West Africa off the coast of Equatorial Guinea. As previously stated the deal increases Chevrons reserves by 18% and does so at a minimal cost of only $5 a barrel with long-term growth potential in the more exotic Israeli and West African gas fields. In incorporating both conventional and unconventional oil assets across a diverse range of locations Chevron are hedging against the geopolitical tensions that have plagued the market for years

Chevron CEO Michael Wirth has lauded the deal as a “cost-effective opportunity for Chevron to acquire additional proved reserves and resources” and is optimistic that it will add value claiming it the deal will be “accretive to free cash flow, earnings and book returns one year after close”. Wirth also referenced a long-term view with this takeover that increases the natural gas reserves in Chevron’s asset base.

With natural gas being less-polluting than the more traditional fossil fuels of oil and coal it has come to be referred to as a transition fuel as the world shifts to cleaner energy production, this position therefore will help Chevron reweight their currently oil-heavy portfolio enhancing their long-term position. Whilst the deal does appear somewhat opportunistic with Chevron taking advantage of the excess cash on their balance sheet in a severe market downturn it is evident that a strategic rationale exists, and the deal would be logical one for the US supermajor regardless of the market climate.

Chevron CEO Michael Wirth. Source: Chevron

With a unanimous approval of the deal by both boards the deal is set to close in Q4, subject to shareholder and regulatory approval, both of which are expected to be granted. The deal is a landmark one for the sector as it marks the first major M&A activity since the widespread lockdowns triggered by COVID-19 and there is now rising speculation that this deal may mark the beginning of a wave of consolidation in the industry. Whilst there are a lot of heavily indebted firms in the sector who are struggling with weak oil prices that may be primed for a cut-price takeover it appears unlikely there will be further consolidation.

With prices only recently back above $40 a barrel many firms are struggling with cashflow, even the industries major players, and with uncertainty over the future of global demand many will choose to maintain a cash buffer for the near-term. Chevron is unique in that they are one of very few firms who have the cash to fund an acquisition in these times and in boasting strong Q1 earnings of $3.6bn there are a financially healthy firm.

The vast majority of firms in the sector lack this balance sheet strength and therefore there exists little appetite for further consolidation. Oil & gas is not only facing the challenges of falling demand and a supply glut – increasing pressure from environmentalist movements means that many investors are cutting their exposure to fossil fuels which in the longer term may mean increased funding costs for oil & gas firms as well as further reducing global demand as consumers increasingly seek ‘green’ products.

Whilst Chevron’s $5bn all-stock acquisition of Noble appears an opportunistic one it also a strategic move. Chevron have diversified their asset base geographically through new positions in the Eastern Mediterranean and West Africa and also diversified their product through expanding their presence in natural gas and unconventional oil. At a modest premium of 7.6% Chevron have got a cut-price deal, especially considering how far Noble’s share price has fallen in recent months. This deal is a landmark one for the oil & gas sector with it marking the first major activity in a post-pandemic landscape. However, it is unlikely to trigger a wave of further deals with few firms having the ability to match Chevron’s financial strength and with concerns over the future of oil prices it is expected that firms will take a cautious approach in the near-term with regards to M&A activity.