Oil Industry in the U.S., Merger and Acquisitions on the Horizon
The higher-than-expected oil price at $50 last week may be short-lived, according to many analysts. For example, according to Goldman, from Bloomberg, “These bullish conditions may not last as Libyan disruptions peak while a return to normal weather in Iraq may spur a recovery in exports... At the same time, Russia, Brazil, Saudi Arabia and the U.S. may continue to boost output. The end of winter may lead to a deceleration in demand growth.” At the same time, Venezuela is facing an economic and political crisis, where U.S. dollars are critical to finance import goods, and where oil production is the best and perhaps only consistent stream of U.S. dollars into the economy. As mentioned above, depleted oil prices have placed the OPEC cartel in jeopardy. Several OPEC members are in dire need of U.S. dollars, so they cannot afford even a minimal reduction in oil production. Furthermore, they cannot even threaten a potential reduction in oil production without fearing economic harm. For instance, Venezuela, after Obama's sanctions, could use oil production as retaliation against the U.S., but Maduro's regime is in desperate need of U.S. dollars, and every dollar of foreign investment counts. Similar situations exist in Mexico, Brazil and Russia. In particular, Russian corporations have to pay bondholders more than $50 million just this year, and that amount of money is not available at the moment in the Russian capital market. Therefore, OPEC is helpless to regulate prices in the short-term. Wood Mackenzie, an energy research organization, found that of 2,222 oil fields surveyed worldwide, only 1.6% would have negative cash flow at $40 a barrel. This figure is most likely correct, but not at the corporation level or country producer level. In particular, emerging market producers depend on government decisions. As politicians in emerging economies face a drop in their country's GDP and encounter political turmoil they are forced to increase subsidies and government reforms using much-needed dollars from the oil industry; with a lower oil price but fixed budgets to meet, the decision will clearly “increase production.” So it is expected, even at an oil price below $40, the supply will be stronger and grow to satisfy the needs for U.S. dollars in countries and corporations in emerging markets. The best strategy for the oil and gas industry in the U.S. is to accumulate cash, reduce expenditure and postpone investments, maintain or increase production, issue equity and bonds, and more importantly look for mergers and acquisitions to happen. American oil and gas corporations are facing a collective debt of more than $200 billion. Similar to emerging market producers, they need to continue pumping hydrocarbons at the same or higher level to maintain cash flow to pay bondholders and wait for stabilization in this industry. Remember, according to the Securities and Exchange Commission (SEC), Drillers calculate the value of their reserves every year using average prices from the first trading days of the 12 previous months, so companies used $95 a barrel in the latest regulatory filings. Companies use the first-trading-day-of-every-month calculation to estimate future cash flow and to tally how much crude was produced from their wells. Thus, it is expected shale drillers report higher reserves. Also, consider the prospects scheduled to be drilled within five years. From E&P company's forecast perspective, numbers are and will look good during the 2015 first semester, despite the current low oil price. Based on SEC regulations, the numbers for this fiscal year look good, but the real question is about the viability of these companies in the mid and long term. It also creates a political issue. At the U.S. oil producer's level, after a new industrial organization with several mergers and acquisitions with bigger and powerful corporations, the government will try to protect this industry to avoid giving back to the monopolistic or cartel power to OPEC. Also, after the 2008 financial crisis, we observed that the U.S. government saved only big banks, taking as their own the saying, “Too big to fail.” Taking a lesson from the government, the American oil and gas industry will likely finish this industrial reorganization process with few corporations that are bigger and stronger with a new regulatory framework. But in the mid and long term, the oil and gas industry is going to be different. The majority of emerging market oil producers needs every dollar they can get, and many governments are not allowing investment in existing or new drillings. So in the near future those producers will face lower output due to lack of investment as well as an expected positive impact in oil price with a higher volatility.
This supports the efforts outlined in the Rawls College of Business Strategic Plan. Learn more about the LEADER 2020 Strategic Plan and follow our progress on Twitter at #RawlsLeads.