Update 2: Why a Deal between Exxon and Pioneer is Bad for the Oil Industry
Exxon Mobil agrees to buy Pioneer Natural Resources
Dear Readers,
Here is a link to the detailed press release: ExxonMobil Announces Merger with Pioneer Natural Resources in an All-Stock Transaction
Also, this is an important point regarding cash deal vs. stocks: the oil giant is also planning to increase its share buyback program to $50 billion through 2024.
We are reposting the article below free of charge for all subscribers.
On October 5, the Wall Street Journal reported that Exxon Mobil was “closing in on a deal” with shale producer Pioneer Energy Resources. While the news triggered an increase in Pioneer’s stock (PXD) by about $20 the following morning, several market observers took the news with a grain of salt. This is not the first time rumors have been circulated about an acquisition of the shale driller. Pioneer’s stock rose by about $20 in the past only to fall fast when it was revealed that the news of a potential deal was based on rumors. What we know so far is that there is an offer on the table and Pioneer’s board will most likely reject it.
Shale was NOT developed by oil majors but by mid-size and small companies. Oil majors entered the shale industry when it was at its peak in terms of valuation, leading to major losses. Some oil giants, especially European companies, exited US shale investment altogether at a later stage.
Today, three oil majors are heavily invested in tight oil plays: Exxon Mobil, Chevron, and ConocoPhillips. In our view, any acquisition of a major shale company, such as Pioneer, by an oil major will create problems and hasten an expected energy crisis. In fact, if Exxon believes that oil demand will not decline below 100 million barrels per day (mb/d) in the next few decades, then it should NOT buy Pioneer.
In what follows, we list the reasons why giant oil companies should not tie up with shale majors, keeping in mind that we need additional investments in oil and gas to avoid future shortages:
1- The alleged $60 billion that Exxon Mobil will pay to buy Pioneer is not an additional investment by the oil major. In fact, this would replace an investment that Exxon would have made elsewhere around the world. As a result, the investment shortage that CEOs and some analysts have been talking about will persist. The world needs investments that bring more oil and gas reserves and not ones that only replace the owners of the resources—as in the case of the alleged potential deal between Exxon and Pioneer.
2- Exxon Mobil’s potential investment amounts to buying existing production, and not developing a new one. The world, however, needs additional production in the coming years.
3- Even if oil majors decide to raise production, any increase will merely be replacing growth somewhere else. Additionally, some may argue that an increase would have happened anyway without the involvement of oil majors.
4- Since buying shale companies is not considered an additional investment, it reflects a shift from long-cycle to short-cycle investment, and from long-life to short-life reserves. A change like that does not help the future financial health of a company on the one hand and would lead to shortages on the other. Shortages, in turn, would generate further government intervention and more pressure on oil majors, as well as more action from the US Congress. Oil majors do not like any of that.
5- Some pundits have suggested that by buying shale companies, oil majors would be shifting from regions around the world with high political risks to low-risk areas in the US. That is not the case. What’s happening is that companies are moving towards strong regulatory regimes, but by doing so they are moving closer to hostile political environments. Environmental, social, and governance (ESG) factors, as well as climate policies, are wreaking havoc on the oil industry. The packages of new climate change laws and regulations in places like Colorado could be adopted by other states in the future. Lawsuits alone could end up driving oil companies out of some states, and probably out of the US altogether. If the UK imposes a windfall profits tax, we should not then be surprised if the US federal government follows suit, knowing that US President Joe Biden himself has threatened oil companies with such a tax.
6- By moving investments from overseas or offshore to onshore tight plays, companies would be moving from heavier and sour crude to lighter crude. The change in crude quality will have a tremendous impact on the oil market, direction of trade, and crude price differentials. Companies like Exxon and Chevron are integrated and are most likely cognizant of the impact. However, the parties that have the final say in decisions to acquire shale companies may not be aware of the big picture. We have already hit a refining wall in the US for light-sweet crude. If shale production continues to grow, many other countries will hit the refining wall too, leading to a surplus of light sweet crude, lower prices, and profit margins.
The world is already suffering from shortages of medium sour crude. Moving investments from medium sour to light sweet crude-producing areas will only exacerbate the problem.
In recent years, the US exported its crude to various countries, including India and China. But let us face it, US producers were lucky: sanctions on Iran and political instability in Nigeria and Libya enabled US crude to reach Southwest Asia. However, once those unstable producers increase output, US producers will have a serious problem maintaining current export levels.
One of the ironies is that tight oil yields large quantities of gasoline relative to heavier crudes. But electric vehicles, as well as the current climate change policies, are expected to reduce demand for gasoline, while demand for heavier oil products is forecast to rise. Based on these estimates, why would ExxonMobil focus on products that are not expected to be in high demand, and leave the ones that will increase its market share?
With respect to electric vehicles specifically, the number of EVs in the coming years could turn out to be way less than expected, and therefore demand for gasoline will increase and tight oil producers will benefit. That begs the question: does Exxon believe that the number of EVs will be less than expected?
7- Moving from conventional oil fields or offshore to tight plays means shifting to gassier plays with more gas and NGLs that fetch lower returns. The value is in the crude with an API lower than 45. In some places in West Texas, gas is flared and sometimes sold at negative prices. NGLs generate only a fraction of the revenues from crude sales.
Conclusions
At this stage, Exxon Mobil’s acquisition of Pioneer Natural Resources remains in the hands of Pioneer Board. The expectation is that the board will reject the offer. Such rejection is good for everyone.
However, if the deal is confirmed, that would be bullish for oil, and more bullish in the medium and long term than our current outlook.
We do not see that by acquiring a key shale producer, an oil major like Exxon Mobil would be reaping long-term benefits. From an energy policy point of view, Exxon should not acquire Pioneer. From an oil market point of view, such an acquisition should not even happen.
This is NOT an ADDITIONAL investment. It is a SHIFT in investment from one location to another, from one crude quality to another, from one type of risk to another, and from oil plays to gassier plays. A potential deal will lead to shale-shale competition. Such changes, while bullish for oil, are dangerous for the world and the future of oil majors themselves. Success stories, such as that of Guyana, are signaling the oil majors to go offshore! EOA