Kerr-McGee Snaps Up HS Resources in Hot Sector

If it's Monday, it's another energy merger.

Kerr-McGee (KMG Quote - Cramer on KMG - Stock Picks) announced plans early Monday to acquire HS Resources (HSE Quote - Cramer on HSE - Stock Picks) in a cash-and-stock deal valued at about $1.25 billion. The purchase calls for Kerr-McGee to assume about $450 million in HS Resources debt.

The deal comes on the heels of last week's blockbuster natural gas deal with Williams (WMB Quote - Cramer on WMB - Stock Picks) agreeing to acquire Barrett Resources (BRR Quote - Cramer on BRR - Stock Picks) for $2.5 billion. Also, Valero (VLO Quote - Cramer on VLO - Stock Picks) agreed to acquire Ultramar Diamond Shamrock (UDS Quote - Cramer on UDS - Stock Picks) for about $4 billion, creating the second-largest domestic refiner.

With three mergers in a week, energy is heating up just like the weather. And analysts -- as well as company executives -- say you can expect deals in the sector to sizzle through the summer.

Hoarding Gas

Like most other energy companies, Kerr-McGee sees natural gas as the key to its future. "The addition of these long-lived natural gas reserves, concentrated near one of the fastest-growing energy markets in the U.S., creates another core operating area for our company that provides significant growth opportunities," said Luke Corbett, Kerr-McGee chairman and CEO, in a prepared statement.

Kerr-McGee's lunge at HS Resources underscores the importance that companies are placing on natural gas. The deal increases Kerr-McGee's natural gas reserves by nearly 80%, at a cost of about $1.10 per thousand cubic feet.

In last week's deal, Williams paid nearly $1.34 per thousand cubic feet for Barrett's proven reserves. However, probable reserves make that price more comparable to Kerr-McGee's offer for HS Resources. "Barrett's future potential reserves are greater than HS Resources'," says John Gerdes, exploration and production analyst at Raymond James. "You don't get the growth potential here that Williams gets with Barrett."

In suggesting the purchase will immediately be accretive to earnings, Kerr-McGee says the deal will increase the company's daily production of natural gas by more than 45% while decreasing the company's lifting costs -- the cost of extracting the gas from the ground -- by about 6%.

Heating Up

With two natural gas companies courted at noticeable premiums in the past week, the emerging trend may put a number of energy companies in play. The trend will continue as long as the price of acquiring energy companies on the open market remains more attractive than drilling new wells in the ground.

"There is a huge disconnect between natural gas prices in the commodities market and prices for gas in the equity markets," says Marshall Adkins, director of energy research at Raymond James. "You can find natural gas at a much better price in the public markets than you can by getting a rig and drilling a hole in the ground."

Adkins acknowledges that the recent drop in natural gas prices on the June New York Mercantile Exchange has pushed toward the $4 mark -- but notes that commodity prices will have to fall much further to dampen interest in acquisitions involving natural gas assets. "Even if gas came down another buck, there would still be a big incentive to make these types of acquisitions," he says. "You are going to see a phenomenal amount of consolidation in the exploration and production area as long as this disconnect continues."

Adkins points to the growing demand for gas in power production as a primary reason for the growing interest in the sector. The addition of nearly 40,000 megawatts of gas-fired power generation in the coming year could raise gas demand by as much as 4 billion cubic feet per day.

And with the trend for natural gas prices pointing higher, everyone wants a piece of the action. He cites Calpine's (CPN Quote - Cramer on CPN - Stock Picks) recent acquisition of Canadian gas producer Encal as yet another example that companies want to own natural gas production rather than rely on the commodities markets and hedge programs to secure supply.

The ability to profit from corporate acquisitions means a number of buyers are surfacing, in addition to the power producers. "If Calpine doesn't do it, Shell (RD Quote - Cramer on RD - Stock Picks) will, or Williams or Kerr-McGee," says Adkins. "There are plenty of willing buyers in the market today."

We recently looked at a number of possible plays in the gas sector and examined possible valuation for acquisitions under the original Shell-Barrett scenario. All of those companies remain in the sights of purchasers looking to grow their natural gas business.

However, according to Gerdes, a couple of companies become logical plays as a result of Kerr-McGee's acquisition of HS Resources. Patina Oil & Gas (POG Quote - Cramer on POG - Stock Picks) and Tom Brown (TMBR Quote - Cramer on TMBR - Stock Picks) now move to the front of the line.

Both have assets in the gas-rich Rocky Mountain region, where HS Resources and Barrett are focused. "The HS Resources deal clearly puts a focus on additional consolidation opportunities in the Rocky Mountain region," Gerdes says. "Tom Brown provides a real growth opportunity. And with the roll-up possibility with HS and Patina, I'd be surprised if Kerr-McGee doesn't consider a purchase of Patina as well." Gerdes rates Tom Brown a strong buy and does not follow Patina. His firm does not provide banking services to either.

And if you still doubt the depth of interest in the natural gas business, heed the comments of one of the deans of the natural gas business, George Mitchell. Mitchell, the founder and chairman of Mitchell Energy & Development (MND Quote - Cramer on MND - Stock Picks), a company often mentioned as a possible acquisition candidate, told reporters at the company's annual meeting last week that suitors continue to call. "We've had people look at us off and on, but we'll see what happens," he said.

Mitchell President Bill Stevens added there is a "wave of consolidation" among natural gas companies, a trend he thinks will continue.

Adds Raymond James' Adkins, "This is a gas story and it will continue to be a gas story. There is still plenty more to come."