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,

Ralph

ZOPAs, Zones of Potential Agreements, Oil Prices as a Catalyst

Deals exist because buyers and sellers place different valuations on assets.   More to the point, when buyers place higher values on a company than sellers, deals can be made.  In theory, a necessary condition for deals to occur is a ZOPA, a zone of potential agreement between buyers and sellers.  For example a seller thinks a company is worth at least 30 euros per share and a buyer is willing to pay 35 euros.   The ZOPA is between 30 and 35 euros.  Where will the deal occur?  If it does occur, it should happen between 30 and 35, the exact value depending on the bargaining power of the two sides.

But a deal won't always happen in a ZOPA.  In fact, evidence indicates that often deals occur outside a ZOPA and fail to happen inside a ZOPA.  Negotiations can be complicated and influenced by all sorts of behavioral and economic factors beside the raw numbers.  A seller may be turned off by the aggressive nature of a bidder, even when an agreement could be reached. A buyer may turn against a deal in the face of increased uncertainty in the economy.

The latter seems to be the case in the oil industry.  A report in the Dallas Morning news reports that deal are in limbo after the recent drop in oil prices.  In our terms, the ZOPAs have disappeared.

All the best,

Ralph