NEW YORK ( TheDeal) -- Royal Dutch Shell's $70 billion purchase of BG Group last week -- at a rich 50% premium -- made it the largest foreign operator in Brazil and boosted its market leadership in liquefied natural gas.
But the deal also highlighted the issue of reserve replacement -- the amount of new oil and gas companies find versus the amount they extract in any given year. Oil and gas companies have been having a hard time replacing reserves.
Shell posted only a 47% reserve replacement ratio last year, versus 137% for BG. Global Hunter Securities estimates the combination will add 25% to Shell's proved oil and gas reserves, boosting them to around 17 billion barrels of oil equivalent, and increase its oil and gas production by 20% to 3.7 million barrels of oil equivalent per day (on a 2014 basis).
The Anglo-Dutch oil and gas giant isn't alone in failing to boost reserves on its own. Several of the larger oil and gas companies fell below the mark last year, including BP plc with a 62% ratio, Chevron (CVX) - Get Report with 89% and Norway's Statoil with 96%. ExxonMobil (XOM) - Get Report, ConocoPhillips (COP) - Get Report, Repsol and Eni did better, each posting more than 100%.
The Financial Times recently posited that 2014 may turn out to have been the worst year for finding oil and gas since 1952 and that the past four years of decline is the longest down streak since 1950. So much for the shale revolution.
Guy Barber, an analyst at Simmons & Co. International, thinks last year's weak reserve replacement could attract attention and become a theme across the industry as capital restraints, postponement of final investment decisions on projects and declining capital expenditures don't typically translate to "a bounty of reserve additions." Analysts at Tudor, Pickering, Holt & Co. Securities don't expect conditions this year to be any better. "Reserve replacement has been pretty lackluster for the integrateds over the past few years and it is likely to be worse this year given lower oil prices and project deferrals, which we expect to lead to reserve write-downs," they said.
The International Energy Agency predicts that the oil industry will need to spend $850 billion per year by the 2030's to boost production or $680 billion each year just to keep today's production levels flat -- hard to justify this year when oil prices are half of what they were last year.
It's long been clear that the easy reserves were found long ago and that it's going to become harder -- and cost more -- to find and extract the new ones. Still, some companies are able to boost their reserves, a factor that has often fueled M&A in the industry. So who has the best reserve replacement ratios in the business?
In late March, Topeka Capital Markets analyst Gabriele Sorbara released a year-end reserves analysis for 56 small-to-large cap exploration and production companies, including the 16 companies he follows. The top five performers on a reserve growth basis (adjusted for sales and acquisitions) include Eclipse Resources (ECR) - Get Report at 353%, Gulfport Energy (GPOR) - Get Report at 305%, RSP Permian (RSPP) at 191%, Synergy Resources (SYRG) at 133% and Sanchez Energy (SN) - Get Report at 129%. Gulfport, RSP Permian and Sanchez also pop up on his list of the top five performers on a production growth basis, along with Diamondback Energy (FANG) - Get Report, which is on his potential takeout list, and Antero Resources (AR) - Get Report.
The three who did the worst in Sorbara's survey? Penn Virginia (PVA) at -15.8%, Bill Barrett (BBG) at -37.9% and Goodrich Petroleum (GDP) - Get Report at -39.5%. And the three worst producers? Not surprisingly, Bill Barrett and Goodrich Petroleum also made that list along with Exco Resources (XCO) .
Of course each company has its own characteristics that might or might not make it a suitable takeover target. Gulfport Energy and Eclipse Resources, which have made some analysts' potential hit lists, both have valuable properties in the Utica but not enough money to develop them -- Eclipse has foregone a potential joint venture in exchange for a $314 million private-investment-in-public-equity deal with EnCap Investments. And Gulfport is expected to benefit from the U.S. Commerce Department allowing some producers to export oil condensate.
RSP Permian might be a good candidate. The producer, which was a portfolio company of Natural Gas Partners before it went public early last year, bought Midland Basin assets in West Texas' Permian Basin from Kayne Anderson-backed Adventure Exploration Partners II and others for $257 million in August, right before oil began its precipitous dive. It's deferred completing some wells until mid-year given where oil and gas prices are but expects to work through its backlog by year-end, according to a Global Hunter Securities report in late March. To raise capital, the company sold shares in a $230 million equity offering in March at a 4.7% discount, along with NGP and TIAA. Tudor, Pickering said the proceeds will improve the company's leverage heading into 2016, when its commodity prices fall off, but the issuance could erode a possible "takeout premium."
Synergy is thought to be more of an acquirer of acreage rather than a seller, particularly in the Wattenberg field in the Denver-Julesburg Basin, after raising $150 million in a public offering, giving it around $265 million in liquidity. "We believe SYRG remains poised to execute on a potentially meaningful transaction in the Wattenberg should an attractive opportunity arise," Global Hunter Securities wrote in a report this week.
As for Sanchez, the company has a master limited partnership, Sanchez Production Partners LP, that it can shed properties into at a good price, avoiding the dilution of its stock through an equity offering and giving it liquidity to chase other projects. Last month it sold wellbore interests in producing oil and natural gas wells in South Texas' Eagle Ford Shale to the affiliate for $85 million and said it may do the same with its midstream assets. Sanchez was thought to be a potential target of Encana Corp. because of its valuable Eagle Ford acreage before the Canadian oil and gas company bought Athlon Energy in September for $7.1 billion.
Could Chevron be a buyer of a company with a better record? Like its largest peers, Chevron has been challenged to replace reserves and boost production, with its organic reserve replacement falling below 100% for two years running. Moody's Investors Service said it's primarily the result of the time lag between reserve bookings and completion of many long-cycle projects. Indeed, the company recently reaffirmed its target of reaching 3.1 million barrels of oil equivalent per day of production by 2017, a 20% jump over last year's levels.
BP has long been thought of as more of a target than an acquirer, although there's still significant risk related to the Macondo oil spill in the Gulf of Mexico, the "wildcard" of its Russian assets and expected weak results in the first quarter, according to Tudor Pickering. "We wouldn't be surprised to see a U.S. unconventional acquisition [by BP]," the analysts said. "BP is cutting capex harder than most super majors and the longer term impact is potentially damaging to growth."
The stronger reserve builders like Statoil and ExxonMobil are clearly in the buyers' seat, with Statoil already rumored to be eyeing EOG Resources Inc, which is active in Texas, the Rockies and the Marcellus, and ExxonMobil thought to be sizing up Bakken player Whiting Petroleum Corp., which could also make sense for Chevron, observers say. But ConocoPhillips is in the middle of a restructuring, which is said to include $1 billion to $2.5 billion in asset sales, and Repsol has its hands full after its bold pickup of Canada's Talisman Energy Inc. for $12.9 billion amid the oil price slide.
Reserve replacement ratios may have been a deal driver in the past. But given current oil and gas prices, executives are focused on other things, including recalibrating their companies' portfolios, boosting their cash flows and keeping up their dividends, according a recent survey by A.T. Kearney. Still, the business is all about oil and gas companies needing reserve-boosting projects to keep their stocks on an upward trajectory.
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