Oil essentials
The crash in commodity prices in late 1998 and into 1999 crushed
companies in the US energy sector that lived too close to the edge.
Some were unable to access capital to drill, which is crucial when
prices drop and companies have to replenish product. For some
independents, a drop in prices is the beginning of a vicious cycle
that leads to takeover. But not all acquisitions are spurred by
desperation or insolvency.
There is significant activity among independent US oil and natural gas producers. Both sectors recovered from depressed prices by mid-year 1999, and companies began to clean up their balance sheets. The cast of characters has been changing as companies acquire or merge and the number of banks involved in the sector continues to change. However, it may be accounting that is at the heart of consolidation activity.
If the equity markets are a good barometer, the scale of investment in the gas and oil sectors is picking up. ?Until recently, energy equities in general performed well throughout the second quarter,? according Fred Leuffer, senior managing director for energy research at Bear Stearns. ?There seems to be a see-saw effect. On days when the tech stocks are down, energy is up, and vice versa. There also seems to be a tug-of-war between growth and defensiveness. It is very unusual for gas and oil to be up at the same time.?
Bruce Schwartz, an analyst with Standard & Poor's who covers the gas and oil sectors, notes that two recent deals ? acquisitions by Devon Energy and Anadarko Petroleum ? mirror in a general what is happening in the energy market. ?Companies are trying to improve their balance sheets and there has been and will continue to be consolidation. I think, generally speaking, that consolidation is being driven by the fact that larger companies can get bigger and in the process can cut costs and experience uplift in reinvestment efficiencies. Also, bigger stocks trade better.?
A major driver of ongoing consolidation is possible accounting changes to be introduced by year-end. Almost all recent mergers and acquisition in the gas and oil sectors have been stock-for-stock transactions. Companies are aware that ?pooling of interests? accounting may go away this year. This has caused companies to pay attention to timing consolidations, taking advantage of the accounting now.
In late May, Devon Energy Corp and Santa Fe Snyder Corp ? both active in exploration and acquisition ? announced they would merge. The merger would form a top-five US-based independent oil and gas company in terms of market capitalisation, proven reserves and annual production. The company will continue to be named Devon Energy Corporation and will remain headquartered in Oklahoma City. Enterprise value of the combined company is estimated at about $9 billion. Some 76% of the company's reserves would be located in North America. These reserves are weighted 58% to natural gas. Morgan Stanley advised Devon on the deal. Chase Securities was financial adviser to Santa Fe Snyder.
Based on preliminary estimates, the combined company will have a capital structure consisting of approximately 126 million common shares outstanding, $150 million in preferred securities, about $1.7 billion of net long-term debt and other long-term liabilities of $400 million. The $1.7 billion debt figure excludes certain Devon debentures that are exchangeable into Chevron common stock. Devon owns 7.1 million shares of Chevron. On a combined basis, the company would have total proved reserves of about 1.1 billion barrels of oil equivalent. Officials expect the merger to result in cost savings of $30 million to $35 million.
The merger is expected to be non-taxable to shareholders of both companies. The accounting method for the merger ? which still is subject to shareholder approval and other conditions ? is expected to be ?pooling of interests.?
Also in May, Anadarko Petroleum Corp and Union Pacific Resources Group (UPR) were granted early termination of the statutory waiting period required under the Hart-Scott-Rodino Anti-Trust Improvements Act by the US Federal Trade Commission (FTC). The agency's action speeds approval of a merger that will create one of the largest independent exploration and production companies in the world in terms of 1999 reserves, production and drilling activity. The combined company will be called Anadarko Petroleum Corporation and will have about 243 million shares outstanding and a market capitalisation over $9 billion. Credit Suisse First Boston (CSFB) and law firm Wachtell Lipton, Rosen & Katz served as advisors to Anadarko for this transaction. Advisors to UPR were the firms of Simmons and Company, Goldman Sachs, and Morgan Lewis and Bockius.
Anadarko expects the merger to be treated as a tax-free reorganisation and accounted for as a purchase. The merger agreement includes a provision under which UPR and Anadarko granted each other the right to purchase 19.9% of each other's outstanding shares. Anadarko believes the proposed merger will be immediately accretive to both cash flow and earnings.
The US Financial Accounting Standards Board has proposed eliminating pooling of interests, one of two principal methods of accounting for business combinations by exchanging common stock. Pooling of interests is accounted for by adding together the book values of combined companies. Pooling of interests is often preferred, but the companies involved in the pooling must meet clearly defined guidelines for independence for a two-year period prior to the acquisition and agree to avoid systematic or pre-planned changes in ownership of the combined operation. However, the easiest method of accounting for a merger or consolidation or other corporate combination is purchase accounting. The original or depreciated cost of assets of the acquired company are written up or down to reflect as much as possible of any acquisition premium or discount. Any remaining acquisition premium is accounted for as good will which must be amortised against earnings over a forty year period.
Schwartz adds that the Devon Energy and Anadarko deals represent a trend of ?very high multiples acquiring lower multiples.? He stressed that recent equity valuations have increased, meaning that investors are interested in both sectors. But the cost of accessing capital from both commercial and investment banks has gone up. ?Just as gas and oil companies began to repair their balance sheets, they were met by turmoil in the capital markets. Now money is tighter. In the mid-1990s, a number of banks entered the gas and oil sectors, hoping to buy market share by coming in lower than banks that were established in the energy markets. Many of these newcomers have since withdrawn from the market. Energy companies have gone from a period of very easy money to a more restricted environment. However, there is still ample money for good companies.?
Rome Arnold, managing director in the global energy group at Credit Suisse First Boston (CSFB), says the Anadarko merger was ?not about cost savings but about complementary skills.? Arnold adds that a large portion of other consolidations in the gas and oil sectors have been spurred by cutbacks in spending on exploration and drilling in the wake of depressed prices during 1998 and early 1999, as well as too many companies competing for the same projects. ?Anadarko's expertise is exploration, while UPR's strength is in exploitation. Since the Anadarko UPR deal was announced, more consolidations have occurred and more deals are expected.?
Arnold notes that fundamentals in the natural gas sector are excellent. ?Things are so good that astute chief executive officers of gas companies should worry about the possibility of political interference. Prices are too high. Return on investment will be off the charts this year.? Arnold said that a hot summer, followed by a cold winter, bodes for the possibility of price controls on natural gas. With prices doubling recently at the wellhead, heating bills could double by yearend.
?Some politicians will naturally be concerned by the impact of high prices on their constituents,? adds Arnold.
Roger Plank, chief financial officer and executive vice-president of Apache Corp, the fifth-largest US independent oil and gas producer, says, ?I am not sure that all energy sector companies have cleaned up their balance sheets. There is a healthy scepticism among investors against throwing money at this industry in spite of record high prices.? Plank notes that historically, when prices have gone up, companies have taken new money to drill. Now, they are taking new money to pay off accumulated debt instead of drilling. ?That says that there may be further spikes in prices before investors come back to gas and oil. Investors are in a state of suspended disbelief.? Plank says reluctance by banks to invest in the sector will wane as high prices are sustained. And the old economy may be taking some of the glitter off the new economy as the market turns against some of the high-tech and e-commerce companies. ?Investors are looking for real earnings, not for companies to go broke. ROE in the gas and oil sector has been 4% recently. I wouldn't be surprised to see further consolidations and mergers in the industry. Consolidation has been happening on the asset side. Companies with too much debt can't drill or acquire.?
Plank adds: ?Throughout 1997 and 1998, we thought oil prices would fall. We curtailed capital expenditures ahead of the crowd and sold off about $200 million in properties. Following the drop in prices, 32 of 34 independent oil producers saw an increase in debt-to-capitalisation. But not us.?
With strengthening prices, in spring 1999, Apache acquired properties in the Gulf of Mexico from Shell Exploration and Production Co for $715 million plus one million shares of APA common stock. Apache financed its cash requirement by issuing 15 million common shares and seven million shares of convertible preferred stock. The balance was funded through existing lines of credit.
Late last year, the company finalised acquisition of Canadian oil and gas properties from Shell Canada for $517 million. That acquisition was financed with internally-generated cash as well as issuing $300 million in commercial paper.
Amongst favourable developments for the US natural gas market is the proliferation of new gas-fired electric generators coupled with the retirement without replacement of several nuclear facilities, limits on adding hydro-electric plants, and increasingly stringent regulations governing the operation of coal-fired plants. Plank stresses: ?The demand for electricity generation is growing at 5% each year. Even with the number of new generating facilities coming on line, demand will far outstrip supply.?
For US oil producers, record high prices, driven by continuing increased global demand and partially tied to the Asian recovery is reason for optimism. But US producers will have to weigh that optimism with the need to drill offshore as onshore US crude production continues to decrease.
There is significant activity among independent US oil and natural gas producers. Both sectors recovered from depressed prices by mid-year 1999, and companies began to clean up their balance sheets. The cast of characters has been changing as companies acquire or merge and the number of banks involved in the sector continues to change. However, it may be accounting that is at the heart of consolidation activity.
If the equity markets are a good barometer, the scale of investment in the gas and oil sectors is picking up. ?Until recently, energy equities in general performed well throughout the second quarter,? according Fred Leuffer, senior managing director for energy research at Bear Stearns. ?There seems to be a see-saw effect. On days when the tech stocks are down, energy is up, and vice versa. There also seems to be a tug-of-war between growth and defensiveness. It is very unusual for gas and oil to be up at the same time.?
Bruce Schwartz, an analyst with Standard & Poor's who covers the gas and oil sectors, notes that two recent deals ? acquisitions by Devon Energy and Anadarko Petroleum ? mirror in a general what is happening in the energy market. ?Companies are trying to improve their balance sheets and there has been and will continue to be consolidation. I think, generally speaking, that consolidation is being driven by the fact that larger companies can get bigger and in the process can cut costs and experience uplift in reinvestment efficiencies. Also, bigger stocks trade better.?
A major driver of ongoing consolidation is possible accounting changes to be introduced by year-end. Almost all recent mergers and acquisition in the gas and oil sectors have been stock-for-stock transactions. Companies are aware that ?pooling of interests? accounting may go away this year. This has caused companies to pay attention to timing consolidations, taking advantage of the accounting now.
In late May, Devon Energy Corp and Santa Fe Snyder Corp ? both active in exploration and acquisition ? announced they would merge. The merger would form a top-five US-based independent oil and gas company in terms of market capitalisation, proven reserves and annual production. The company will continue to be named Devon Energy Corporation and will remain headquartered in Oklahoma City. Enterprise value of the combined company is estimated at about $9 billion. Some 76% of the company's reserves would be located in North America. These reserves are weighted 58% to natural gas. Morgan Stanley advised Devon on the deal. Chase Securities was financial adviser to Santa Fe Snyder.
Based on preliminary estimates, the combined company will have a capital structure consisting of approximately 126 million common shares outstanding, $150 million in preferred securities, about $1.7 billion of net long-term debt and other long-term liabilities of $400 million. The $1.7 billion debt figure excludes certain Devon debentures that are exchangeable into Chevron common stock. Devon owns 7.1 million shares of Chevron. On a combined basis, the company would have total proved reserves of about 1.1 billion barrels of oil equivalent. Officials expect the merger to result in cost savings of $30 million to $35 million.
The merger is expected to be non-taxable to shareholders of both companies. The accounting method for the merger ? which still is subject to shareholder approval and other conditions ? is expected to be ?pooling of interests.?
Also in May, Anadarko Petroleum Corp and Union Pacific Resources Group (UPR) were granted early termination of the statutory waiting period required under the Hart-Scott-Rodino Anti-Trust Improvements Act by the US Federal Trade Commission (FTC). The agency's action speeds approval of a merger that will create one of the largest independent exploration and production companies in the world in terms of 1999 reserves, production and drilling activity. The combined company will be called Anadarko Petroleum Corporation and will have about 243 million shares outstanding and a market capitalisation over $9 billion. Credit Suisse First Boston (CSFB) and law firm Wachtell Lipton, Rosen & Katz served as advisors to Anadarko for this transaction. Advisors to UPR were the firms of Simmons and Company, Goldman Sachs, and Morgan Lewis and Bockius.
Anadarko expects the merger to be treated as a tax-free reorganisation and accounted for as a purchase. The merger agreement includes a provision under which UPR and Anadarko granted each other the right to purchase 19.9% of each other's outstanding shares. Anadarko believes the proposed merger will be immediately accretive to both cash flow and earnings.
The US Financial Accounting Standards Board has proposed eliminating pooling of interests, one of two principal methods of accounting for business combinations by exchanging common stock. Pooling of interests is accounted for by adding together the book values of combined companies. Pooling of interests is often preferred, but the companies involved in the pooling must meet clearly defined guidelines for independence for a two-year period prior to the acquisition and agree to avoid systematic or pre-planned changes in ownership of the combined operation. However, the easiest method of accounting for a merger or consolidation or other corporate combination is purchase accounting. The original or depreciated cost of assets of the acquired company are written up or down to reflect as much as possible of any acquisition premium or discount. Any remaining acquisition premium is accounted for as good will which must be amortised against earnings over a forty year period.
Schwartz adds that the Devon Energy and Anadarko deals represent a trend of ?very high multiples acquiring lower multiples.? He stressed that recent equity valuations have increased, meaning that investors are interested in both sectors. But the cost of accessing capital from both commercial and investment banks has gone up. ?Just as gas and oil companies began to repair their balance sheets, they were met by turmoil in the capital markets. Now money is tighter. In the mid-1990s, a number of banks entered the gas and oil sectors, hoping to buy market share by coming in lower than banks that were established in the energy markets. Many of these newcomers have since withdrawn from the market. Energy companies have gone from a period of very easy money to a more restricted environment. However, there is still ample money for good companies.?
Rome Arnold, managing director in the global energy group at Credit Suisse First Boston (CSFB), says the Anadarko merger was ?not about cost savings but about complementary skills.? Arnold adds that a large portion of other consolidations in the gas and oil sectors have been spurred by cutbacks in spending on exploration and drilling in the wake of depressed prices during 1998 and early 1999, as well as too many companies competing for the same projects. ?Anadarko's expertise is exploration, while UPR's strength is in exploitation. Since the Anadarko UPR deal was announced, more consolidations have occurred and more deals are expected.?
Arnold notes that fundamentals in the natural gas sector are excellent. ?Things are so good that astute chief executive officers of gas companies should worry about the possibility of political interference. Prices are too high. Return on investment will be off the charts this year.? Arnold said that a hot summer, followed by a cold winter, bodes for the possibility of price controls on natural gas. With prices doubling recently at the wellhead, heating bills could double by yearend.
?Some politicians will naturally be concerned by the impact of high prices on their constituents,? adds Arnold.
Roger Plank, chief financial officer and executive vice-president of Apache Corp, the fifth-largest US independent oil and gas producer, says, ?I am not sure that all energy sector companies have cleaned up their balance sheets. There is a healthy scepticism among investors against throwing money at this industry in spite of record high prices.? Plank notes that historically, when prices have gone up, companies have taken new money to drill. Now, they are taking new money to pay off accumulated debt instead of drilling. ?That says that there may be further spikes in prices before investors come back to gas and oil. Investors are in a state of suspended disbelief.? Plank says reluctance by banks to invest in the sector will wane as high prices are sustained. And the old economy may be taking some of the glitter off the new economy as the market turns against some of the high-tech and e-commerce companies. ?Investors are looking for real earnings, not for companies to go broke. ROE in the gas and oil sector has been 4% recently. I wouldn't be surprised to see further consolidations and mergers in the industry. Consolidation has been happening on the asset side. Companies with too much debt can't drill or acquire.?
Plank adds: ?Throughout 1997 and 1998, we thought oil prices would fall. We curtailed capital expenditures ahead of the crowd and sold off about $200 million in properties. Following the drop in prices, 32 of 34 independent oil producers saw an increase in debt-to-capitalisation. But not us.?
With strengthening prices, in spring 1999, Apache acquired properties in the Gulf of Mexico from Shell Exploration and Production Co for $715 million plus one million shares of APA common stock. Apache financed its cash requirement by issuing 15 million common shares and seven million shares of convertible preferred stock. The balance was funded through existing lines of credit.
Late last year, the company finalised acquisition of Canadian oil and gas properties from Shell Canada for $517 million. That acquisition was financed with internally-generated cash as well as issuing $300 million in commercial paper.
Amongst favourable developments for the US natural gas market is the proliferation of new gas-fired electric generators coupled with the retirement without replacement of several nuclear facilities, limits on adding hydro-electric plants, and increasingly stringent regulations governing the operation of coal-fired plants. Plank stresses: ?The demand for electricity generation is growing at 5% each year. Even with the number of new generating facilities coming on line, demand will far outstrip supply.?
For US oil producers, record high prices, driven by continuing increased global demand and partially tied to the Asian recovery is reason for optimism. But US producers will have to weigh that optimism with the need to drill offshore as onshore US crude production continues to decrease.
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