U.S. Oil Consolidation is Around the Corner

Thesis: With the recent drop in crude oil prices, smaller U.S. shale companies are going to start being acquired at a rapid clip by larger rivals.

Crude oil prices dropped form over $100 a barrel to the low $40’s per barrel and are now hovering around $48 a barrel. The reason why prices were able to drop so severely is because the United States (a typically heavy importer of oil) experienced a boom in shale by a process known as hydraulic fracturing. These reserves added to the global supplies resulting in an oversupply of crude oil causing the price to drop. Furthermore, OPEC (the largest oil producing organization in the world) decided not to cut oil production in the region (which was the typical policy in order to keep prices elevated). Now you may be wondering why OPEC would do such a move. Many producers in that region can drill and get oil out of the ground around $10 a barrel, so even at $48 a barrel they are profitable. Now the U.S. shale companies have a much higher cost of drilling and getting oil out of the ground. The most efficient can manage $40 a barrel, but the norm is closer to $50 a barrel, and many can’t even produce at those levels according to an article published by CNBC.

Many small U.S. companies set out on oil exploration projects and used leverage (or debt) to finance the projects. But now, the price of crude oil is below their drilling costs to get it out of the ground. So they are highly leveraged, not capable of making net profits, and are unable to attain financing to grow. So why would anyone want to acquire one of these companies? The answer: their oil reserves and land. Large oil giants such as Exxon Mobil XOM or Chevron CVX are able to purchase these smaller, struggling companies at an incredible discount right now. They have the capital and pipelines to continue operations and can boost their oil reserves by purchasing these smaller companies. A Bloomberg article titled “Get Ready for Oil Deals: Shale is Going on Sale” mentions some of the top buyout targets. The reason why now is the time for deals to start occurring is because crude oil has been below $60 a barrel for all of 2015 and prices below $50 a barrel for half of that time frame. So these smaller companies have experienced an entire quarter of producing at losses with no medium term catalysts for crude prices to rally in sight. The main tradeoff is that the smaller companies get to avoid bankruptcy or further share price decline while the larger companies who can tolerate the losses in the short term receive a big discount in acquiring oil reserves.

One thought on “U.S. Oil Consolidation is Around the Corner

  1. David Farnum

    I agree with the idea that the United States will likely see massive conglomeration in the oil industry due to these low oil prices, but headwinds remain. It makes sense that these “smaller” companies might not be willing to sell themselves when they are at a low point (ie. a lower valuation). It does not make sense for these companies to auction themselves just because of a temporary downside risk to their business plan.

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