Merger and acquisition activity in the U.S. oil and gas sector has surged to almost $200 billion in the past year. This occurred as the biggest producers swallowed up smaller rivals in a race for scale that has redrawn the energy landscape in the U.S. The industry has gone from about 65 to 41 publicly traded oil and gas companies in the U.S. in less than five years.
Not surprisingly, the country’s richest shale area - the Permian Basin - has been the focus of much of the activity over the past five years.
Just since last July, companies including ExxonMobil (XOM), Chevron (CVX), and Occidental Petroleum (OXY) have announced nearly $200 billion worth of deals in the shale patch.
The latest deal came on May 29, when ConocoPhillips (COP) announced a $22.5 billion all-stock acquisition of Marathon Oil (MRO). Marathon shareholders will receive 0.255 share of Conoco for each Marathon share they own.
This tie-up is worth a closer look, because it's different from the prior energy sector deals.
Conoco Buys Marathon
The dealmaking in America’s oil patch has entered a new phase. With much of the best acreage spoken for in the prolific Permian Basin of Texas and New Mexico, companies are now being forced to look further afield. Consolidation has left almost two-thirds of the Permian Basin’s shale oil in the hands of just six companies, according to the energy consultancy Rystad.
Conoco’s deal for Marathon signaled this shift in the oil patch M&A. The company had lost out to Diamondback Energy (FANG) in its attempt to buy Endeavor Energy Resources, one of the prized targets in the Permian.
Conoco had already expanded in the Permian in recent years through a $13 billion takeover of Concho Resources and a $9.5 billion purchase of the assets of Shell PLC (SHEL) in the region.
With the loss of Endeavor, Conoco struck off in a different direction and went after Marathon, which holds some Permian acreage. But a big chunk of its assets are scattered across less well-known basins, such as Texas’s Eagle Ford, North Dakota’s Bakken, and Oklahoma’s Scoop Stack. The deal also hands the company reserves as far afield as Equatorial Guinea.
And, make no mistake - it is a BIG deal. Conoco expects the takeover will add resources totaling the equivalent of 2 billion barrels to its inventory.
The acquisition will give ConocoPhillips an output larger than supermajor TotalEnergies SE (TTE), and on par with BP PLC (BP), according to energy consultancy Wood Mackenzie.
In addition, Conoco, Exxon, and Chevron will together account for 25% of remaining U.S. shale oil resources, according to Rystad Energy. Rystad added that Conoco will now be elevated into second position in terms of total inventory in the Lower 48 core tight oil plays, just behind ExxonMobil, and for a relatively cheap price.
Conoco Does It Again
But unlike the supermajors, Conoco got rid of its refineries more than a decade ago. And for the past five years, the company has smartly honed its portfolio to break even at less than $40 a barrel for oil, leaving ample headroom for buybacks and dividends.
With the deal for Marathon, Conoco believes it will have roughly 2,000 locations across several U.S. regions where the company can go back into older, lower-producing shale wells and frack them again.
That will allow Conoco to take advantage of new hydraulic fracturing techniques for blasting water, sand, and chemicals underground to release trapped hydrocarbons. This is what is called a refrack.
Refracks should be able to extend some of its top-tier drilling locations in North Dakota’s Bakken and South Texas’s Eagle Ford shale plays. Prior to this deal, Conoco’s output from these fields was expected to be flat at best.
Conoco has had a reputation for disciplined spending and financial stability. In January 2021, it completed its aforementioned acquisition of Concho Resources at a price that was, in hindsight, a steal.
I believe this takeover of Marathon will be another winner.
The companies are alike in that Marathon also is a cash cow, with one of the highest free cash flow (FCF) yields among the leading exploration and production companies.
Conoco itself has always focused on a low cost of production and a diverse asset base to generate FCF, even when oil (CLN24) and gas (NGN24) prices are low. The year 2020 proved to be a litmus test for the company, as it eked out $87 million in FCF during the severe downturn in the energy industry.
The company sees the deal closing in the fourth quarter, pending regulatory approvals. After that point, Conoco says its share buybacks will top $20 billion for the next three years, with more than $7 billion in the first full year, assuming recent commodity prices. The company also plans to increase its base dividend by 34% to 78 cents per share starting in the fourth quarter.
Conoco had previously laid out a plan to return at least 30% of operating cash flow to its shareholders per year through a three-tier capital return program consisting of buybacks, an ordinary annual dividend, and a variable component.
Conoco management has done it again with this Marathon deal, expanding its lead as the largest of the “super-independent” oil firms in the U.S. COP stock is a buy under $120.
