Conoco to Buy Concho for $9.7 Billion to Create Shale Giant
Comment of the Day

October 19 2020

Commentary by Eoin Treacy

Conoco to Buy Concho for $9.7 Billion to Create Shale Giant

This article by Kevin Crowley and David Wethe for Bloomberg may be of interest to subscribers. Here is a section:

Houston-based Conoco emerged from the oil market slump in a relatively strong position with about US$7 billion of cash on hand. It recently resumed share buybacks. But its growth outlook is challenged: second-quarter production was down by almost 25 per cent from a year earlier after it joined many other US drillers in curbing output in response to lower prices.

Adding Concho will dramatically alter its production profile. The Midland, Texas-based shale company is entirely focused on the Permian and pumped 319,000 barrels in the second quarter, about six times what Conoco produced there.

The combination will save US$500 million a year by 2022, and hand shareholders more than 30 per cent of cash from operations through dividends and other distributions, the companies said.

The Conoco-Concho deal may also signal further mergers and acquisitions in the sector. Despite a compelling rationale for more consolidation in order to cut costs, a lack of cash and Wall Street's antipathy toward the sector has made it hard to get deals across the line.

Eoin Treacy's view

The USA is the global swing producer of crude oil. Not only does it have ample supply but the government is not reliant on revenues from oil to support its social programs. Together with the unique production profile of unconventional wells, supply can be tailored to the price environment. The one challenge that has impacted profitability has been the high cost of production. The large number of independent producers has been a factor in that condition.

Shale is a capital-intensive production model. It makes sense that as prices fluctuate the sector will consolidate around the producers best able to deploy capital in an efficient manner to lower the cost of production and ensure profitability. That will, over time, increase the resilience of the sector to occasional prices drawdowns while also lowering the global marginal cost of new production.

This year Conoco bought Concho and Chevron bought Noble Energy. Both shares are significantly above their March lows while some of the other majors who have not been as fleet-footed are testing their lows.  

The USA’s rig count appears to be bottoming and crude oil prices are steadying in the region of the trend mean and the psychological $40 area.

Car ownership has surged during the pandemic, even as miles driven has plummeted. Anecdotal reports of intense traffic in cities like London suggests more people will be driving when the lockdowns end. That suggests plenty of scope for a demand shock.  

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