Breaking Records Despite Slumping Crude

Matthew Carr By Matthew Carr, Emerging Trends Strategist, The Oxford Club

Market Trends

The energy sector has been battered in 2017.

Shares of oil and natural gas companies have lagged the broader markets. And that means a lot of companies are trading at a discount.

That’s true for not only investors… but also corporations.

Last year, global merger and acquisition (M&A) activity totaled $3.9 trillion. This was a 17% decline from the $4.7 trillion in 2015.

Don’t let the “decline” fool you. Both are the highest levels we’ve seen since 2007.

And that was despite shocks like “Brexit” and crude prices bottoming out.

In 2017, M&A activity is expected to maintain an elevated pace. And with crude and natural gas prices low, we should continue to see a flurry of M&A activity here.

In fact, companies like Stone Energy (NYSE: SGY) and Penn Virginia (Nasdaq: PVAC) have already stated that they are looking for all strategic avenues to “maximize shareholder value.”

Shares of both companies are down more than 30% this year. And Stone Energy’s shares are down 85% from their high in July 2016.

In the first quarter of this year, M&A activity in the U.S. energy sector was up 160% to $73.04 billion. This was a first quarter record in terms of deal value. Meanwhile, the total number of deals increased 36% year over year to 53.

Of those totals, the upstream segment accounted for 32 of those deals, worth $36.6 billion. The Permian Basin alone represented 20 of those deals, worth $21.36 billion…

This is a record for M&A activity in the Permian.

Come Together

But here’s what energy investors really need to understand: From the third quarter of 2016 through the first quarter of 2017, there was $221 billion worth of M&A activity in the U.S. energy sector. This was more than the previous five quarters combined.

Canadian M&A activity is also ramping up. It’s at its most robust pace since 2007. So far, $132 billion worth of deals has been done in the Great White North in the first six months of 2017.

And energy represents the biggest piece of the pie…

Who are the players in these deals? For the most part, foreign companies like ConocoPhillips (NYSE: COP), Marathon Petroleum (NYSE: MPC), Royal Dutch Shell (NYSE: RDS.A) and Statoil (NYSE: STO) are unloading their Canadian oil sands assets to companies in Canada.

The costs to develop and operate these fields are too high for foreign companies, especially in today’s current market. Right now, the break-even point in Canada’s oil sands is between $60.52 per barrel and $75.73 per barrel in terms of WTI equivalent.

Remember, Canadian oil trades at a discount to WTI because it is lower quality and has to travel much farther to be refined. Plus, oil sands producers must pay royalties in Alberta between $7.14 and $13.50 per barrel.

With U.S. crude currently trading around $45, most foreign players just don’t see it being worth the effort.

Domestic companies are more prone to take risks on oil sands projects at the moment.

So as foreign companies dump their assets, 80% of all oil sands production in Canada now comes from Canadian companies.

The Message Remains the Same

Companies and investors must follow the same cardinal rule: Buy low, sell high.

M&A records are being set in the energy sector – and it’s all thanks to crude’s swooning prices.

In these markets, companies will continue to dump their high-cost projects and try to gobble up as much low-cost acreage as they can.

In other words, they’re taking the opportunity to broaden their portfolios while prices are cheap. Investors should do the same.

Good investing,

Matthew

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