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The Argument for Consolidation in the Oil and Gas Industry

State of the Oil and Gas Industry

We have seen two price crashes and a lot of money leaving the oil and gas industry in the past five years. Policies designed to increase the usage of renewables have been springing up around the world and firms are finding it difficult to improve margins without expanding. ExxonMobil, Chevron, BP, and Shell recorded more than $50 billion in losses between them last year due the demand side shocks which caused prices to fall from $60 a barrel to $20 in early January 2020. The industry must reshape itself to stay relevant and counter threats arising from regulation and government policy. Perhaps M&A activity can make firms more resilient financially and operationally if historical market trends are to be looked at.

Previous Market Trends

In the late 1990s, a $300 billion wave of oil mergers was a direct result of the crude price collapse. Mobil’s chief executive Lou Noto gave a famous warning to the industry. “We need to face some facts, the world has changed, the easy things are behind us. The easy oil, the easy cost savings, they’re done. So, all of us are now looking for some way to make a jump “. The super-large companies which were created from those deals now face a more troubling situation financially and face a booming clean energy sector confident it can entirely wipe out the oil and gas industry.

The chart above shows major deals that took place during periods of low crude oil prices. These deals led to the creation of ‘supermajors’ in the industry with stand-alone entities being bought by larger firms with a lot of cash to spend. After the completion of the deals, prices tended to rebound, and firms were financially stronger and could employ economies of scale to capitalise on increased demand while also finding it more feasible to deal with supply cuts.

Current Market Trends

Darren Woods, Exxon Chief Executive, stated earlier this year that the company was looking for deals with companies that could complement its portfolio. According to some analysts and FT, this was a nod to Chevron. Supermajors currently have a lot of debt that has grown over the past decade. Consolidating can help firms manage their debt better due to superior financial positions being adopted through M&A. The overall market trend involves some focus on M&A as firms have hinted at employing a strategy designed to increase scale and profitability to combat an increasingly challenging environment.

Benefits of M&A for the Industry

Engaging in M&A can bring significant synergies. Combined entities will have a larger portfolio which will add to gross revenue. In addition, the opportunity to produce and sell more barrels per day will increase average revenue. A tie up between US companies can create more profitable portfolios which can compete with low-cost competitors based in Russia and the Middle East. Scalability will increase with increased output and average cost will decrease. This can be used a survival strategy to deal with shrinking oil demand in the next few decades.

The current market gives a lot of structural power to firms in Russia and Middle East over American Companies. Merging will not only give supermajors more output which would improve their competitiveness, it will also give access to markets which are still very oil friendly which mainly consist of emerging markets. This would allow firms to lobby governments more effectively to pressure OPEC into making decisions favourable for supermajors. This is very important considering middle eastern countries don’t mind putting downward pressure on the price of crude oil to increase exports. Merging would be a better tool to combat competitors. The graph below shows Chevron and Exxon would produce more barrels per day than OPEC leaders aside from Saudi Arabia.

Why 'Supermajors' should Combine?

The oil and gas industry is at a point where it must be resilient in the face of demand and supply shocks. Scalability can help reduce costs and increase revenues which will help firms deal with the likely possibility of reduced oil demand in the next few decades. M&A will also help firms navigate markets better and tap into emerging markets which are still very oil dependent. In addition, firms will be able to deal with political pressures arising from OPEC and Russia efficiently if they can match their daily oil production making them key players in the industry which will increase their lobby power. Overall, I believe the industry is ripe for M&A and must consolidate if it wants to have a positive outlook in order to attract investment.

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