Merger Talks Feed Energy Sector Deal Speculation

Posted by Joseph R. Fonseca November 16, 2014

Talks that could lead to oilfield services provider Halliburton Co buying rival Baker Hughes Inc may herald increased deal-making in the energy business as companies bet on a protracted drop in oil prices, industry bankers said.

Competing service companies including National Oilwell Varco Inc and Weatherford International may also be targets, bankers and lawyers said. In any deal, the incentives will be the same: consolidation would allow them to better weather the downturn and resist pressure from oil producers to slash prices.

The Baker Hughes/Halliburton talks have stalled after the companies weren't able to agree on issues including price, people familiar with the matter said Friday.

As oil prices fall, oil field service companies get squeezed, one industry lawyer said. That's because when prices fall far enough, it's no longer economical to get oil out of the ground. If it's too expensive to drill, there's no need to pay an oilfield service company. "The services guys are the last marginal dollar," the lawyer said.

While services companies are likely to feel the effect of lower oil prices sooner, overleveraged exploration and production companies may also be pushed to do deals over the medium term, bankers said. Such companies could include Apache Corp, Hess Corp, Marathon Oil Corp or Devon Energy Corp, bankers said.

Those four exploration companies along with the oil services companies including Baker Hughes, all have market values that range between about $20 billion and $31 billion.

In the end, price expectations will decide whether upstream exploration and production companies turn into sellers. If sellers' management believe the oil price will rebound fairly soon, sellers would wait until then, hurting chances for large deals. Brent crude traded at $79.60 a barrel on Friday, down from $115.06 on June 19.

Until prices stabilize, exploration and production company deals will likely remain asset-level deals in distressed situations such as Samson Resources' sale of its Bakken assets.

"Certainly there will be instances where you will find more compromised balance sheet operators possibly being more inclined to sell their entire position," said Ted Harper, a fund manager at Frost Investment Advisors LLC in Houston.

Not all will be targets, he said. Some exploration and production companies will seek to buy at a discount additional potential reserves near where they are already drilling "to enhance returns from existing production," he said.

Because exploration and production companies will slow or stop drilling if they are not making money, there is enormous pricing pressure on oil field services providers as oil prices fall.

Indeed, the tumbling price may have pushed the companies into a dialog, especially if Halliburton's management believes that oil prices could remain low for some time.

While Halliburton "has first mover advantage" in its bid to acquire Baker Hughes, "it's common knowledge that Schlumberger made a run at Baker Hughes years ago to plug a major hole in (well) completions. That hole remains unfilled," Bill Herbert, oilfield analyst at energy-focused investment bank Simmons & Co told clients on Friday.

"Further, GE is lurking in the shadows as well, manufacturing cultures are comparable," said Herbert. General Electric Co. has a large oil and gas business.

While another bidder for Baker Hughes may not emerge, oilfield services companies and private equity firms will be looking to buy up any Baker Hughes business units shed to meet antitrust requirements if the Halliburton deal goes through, bankers said.

"There is going to be reasonably competitive bidding on the part of the General Electrics, the National Oilwell Varcos and some of the midcap players," said Frost's Harper.