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The State of the Oil Industry, Part 3

Will we see a wave of mergers and acquisitions in the near future?

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Aug 18, 2020
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Royal Dutch Shell (

RDS.A, Financial)(RDS.B, Financial) cut its dividend for the first time since World War II back in the first quarter of the year. Now, while this undoubtedly spooked investors, and many oil majors have been loath to follow suit, (ExxonMobil (XOM, Financial), for instance, took on more debt and slashed other expenses just so it could maintain its payouts), there is a silver lining to being the first to do such a thing - now that the proverbial band-aid has been ripped off, management can move forward and reposition the company and, of course, have left the door open to a progressive increase of the dividend in the future.

This example demonstrates that short-term disruptive events can end up being a boon to some market participants in the longer term. The collapse in oil prices has hit smaller producers comparatively harder than the majors (who have stronger balance sheets), so it's possible that we will see some renewed level of mergers and acquisitions in the coming years.

Time to consolidate?

It's not unusual for a sector to consolidate after a traumatic market event. The U.S. banking industry has become a virtual oligopoly after the 2008 financial crisis, during which smaller regional banks who didn't have access to federal funding were wiped out and snapped up by their larger competitors.

Last month, Chevron (

CVX, Financial) acquired Noble Energy (NBL, Financial) for $5 billion in an all-stock purchase, potentially laying the groundwork for more deals. Chevron ended up offering $5 per barrel of Noble's proven oil reserves, a similar deal to the one they extended to Anadarko last year before the Warren Buffett (Trades, Portfolio)-backed Occidental (OXY, Financial) bid won out. Other oil majors like ConocoPhillips (COP, Financial) and Total (TTA, Financial) also have deep pockets that they might dip into to make acquisitions at this time of depressed valuations.

Mergers tend to beget mergers. Once the market is reset, it gives prospective takeover candidates a benchmark to aim for in their negotiations with the acquiring companies, so it seems not impossible that we will see more such deals in the near future. At the same time, there is still a fair amount of uncertainty around the future for oil demand, so it's not as if the big players can go on a reckless spending spree in an age where their own dividends and buyback programs need to be protected.

What's more, many smaller oil producers are carrying larger amounts of debt on their balance sheets than they have in the past, so any potential suitor has to understand that it will be marrying those liabilities, not just the assets. For all these reasons, the most likely outcome is that M&A activity will continue at a subdued pace (if the price is right), but is unlikely to become a headline grabbing trend in the near future.

Disclosure: The author owns no stocks mentioned.

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