Energy Deals Pick up as Market Deals Grind to a Halt
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Despite the upward-moving market, new M&A and IPO announcements are scarce, causing investors to worry if the new highs are sustainable. Was the run-up legitimate, or was it induced by Bernanke? Energy companies worry less about this question, as they are in their own little world – because in the oil and gas space, deals are alive and well.
Volatile natural gas and oil prices have kept both upstream and downstream energy companies on their toes. Natural gas prices have fluctuated from around $2.38 on June 13 to as high as $3.22 on July 30, a 35% move. And oil is no different. One barrel of oil has jumped from $78.73 on June 28 to $100.73 on September 14, a move of nearly 28%.
The resulting price moves have spurred some heavy deal-making. Here are a few of the major deals, and how you can trade the sector by watching the deal-making.
Huge, Hot Deals
On Wednesday September 19, ExxonMobil (NYSE: XOM) VP Ken Cohen blogged about the rich Bakken Shale region, which has upped production from 6,000 barrels of oil per day in 2006 to 600,000 barrels per day now. The very next day, Exxon announced that it would transfer some of its old oil fields and pay $1.6 billion to Denbury Resources (NYSE: DNR) to buy that very same Bakken Shale.
Denbury is more conservative than its peers, as it prefers to drill old oil wells instead of new ones. Further, oil makes up more than 90% of its output, while competitors produce roughly one-third oil and related products and two-thirds natural gas products.
Like Exxon, Plains Exploration and Production (NYSE: PXP) has ambitious goals of jumping into hot drilling sectors. Plains recently loaded up on debt to pay BP $5.55 billion and Royal Dutch Shell (NYSE: RDS-A) $560 million for offshore drilling operations in the Gulf of Mexico.
To fund the deal, Plains borrowed $7 billion – a staggering amount considering the company’s market cap is only $4.8 billion. The deal triples Plains’ oil production to 300,000 barrels per day, with 200,000 now coming from the offshore drilling deal. BP, on the other hand, trimmed its asset base so that it could focus on a few high-production wells, and so that it could come closer to its goal of raising $38 billion to cover costs from its 2010 oil spill.
Finally, Chesapeake (NYSE: CHK) sold part of its holdings in Texas’ Permian Basin to a few firms, including Chevron and Shell. Though Shell already holds land in the Basin, it added 618,000 acres for a reported $1.9 billion.
The deal raised $3.3 billion for Chesapeake, and the firm still kept 470,000 acres of land, a nice play in case natural gas were to jump again. Chesapeake also has more deals in the pipeline. CEO Aubrey McClendon plans to shed $13 to $14 billion in assets to cover capital expenditures and funding gaps.
Trading the Deals
How can investors trade deals like these over the long-term? One suggestion is forming your own framework for evaluating and acting on deals. For example, let’s say that you are bullish on natural gas, and you also think that the economy is going south, taking oil with it. What would be a good play? Ideally, it would be a company with high natural gas output that is scooping up natural gas assets on the cheap. Combing through quarterly filings would tell you whether your play is Chevron, Exxon, Shell, or the riskier Chesapeake.
A sample framework could look like this:
- Find your bullish or bearish energy bias – assume you are bearish natural gas, bullish oil.
- Find the company that holds assets and executes deals that closely match your bias – in this case, Denbury Resources would be a nice fit. Over 90% of the company’s production is oil-based, and it prefers to drill in older, conservative wells as opposed to hot new wells.
- Make the trade – identify your risk tolerance and pull the trigger.
With these opinions, Denbury is a good choice because the stock is weighted towards the price of oil, shielding it from much of the volatility inherent in natural gas. Moreover, “60% of its oil was sold at prices based wholly or partly on the Louisiana Light Sweet, or LLS, benchmark due to the proximity of many of its fields to the Gulf of Mexico Coast,” The Wall Street Journal reports. In 2012, the average premium for LLS over West Texas Intermediate was $16 per barrel.
The overall market has been slow at best, and deal flow has paused. However, the constant asset sales and swaps of oil and gas companies provide a nice diversion from the broader market.
In a market downturn, investors will have an opportunity to scoop up stocks at far lower valuations. Thus, use any pullback to load up on stocks that meet your long-term opinions and biases.
ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of Denbury Resources and ExxonMobil and has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, long JAN 2013 $25.00 calls on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.