Thursday, April 9, 2015

Merger Waves in the Oil Industry?

We've talked about merger waves in previous posts, noting that typically some catalyst occurs that makes acquisitions attractive in a particular industry.  Typical catalysts include changes in regulation, consumer tastes, or economic factors within an industry.  Something changes within an industry that makes buying companies desirable.  A major catalyst affecting oil companies is the dramatic drop in the price of oil.

This isn't the first time this has happened.  It occurred most famously in the 1980s as oil dropped from $40 a barrel to $10 and interest rates rose from single to double digits.  Picture how those two changes factor into the present value equation and you will know why drilling for oil became a negative net present value situation.  Anyone who could turn off the let's drill button could create value in a company.  A famous case is the acquisition of Gulf Oil.  It was trading at $38 before the acquisition and overnight the price jumped to $80 as acquisition became imminent.  The source of the $40 plus gain per share can be completely explained by the value created by ending drilling.

Today's situation is a little different, but it looks like we are again set for a wave of oil mergers following the  Royal Dutch Shell's $70 billion acquisition of London's BG Group  announced Wednesday.

As an article in today's news notes, it now appears cheaper to buy oil by buying companies on Wall Street than by drilling for it.  It will be interesting to see what happens.

All the best,


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