The American shale industry is a testament to the inventive spirit of grassroots capitalist enterprise. This sector was revolutionized by innovative frackers, who introduced groundbreaking methods of horizontal drilling and oil extraction from rock formations.
Pioneer Natural Resources, an industry-leading shale specialist, significantly contributed to this upsurge by boosting domestic oil production from 8 million barrels per day in 2005 to 15 mbpd in 2015, transitioning America from a net oil importer to an exporter.
However, not all major oil companies rushed to capitalize on the shale boom with the same zeal. Global oil giant Exxon Mobil Corporation (XOM) cautiously approached the rich shale territory, such as the Permian basin, due to the reckless expansionism of the wildcatters, consequently burning billions of investors' funds.
However, intentions regarding shale developments from the oil titan have shifted recently. In June, Darren Woods, CEO of Exxon Mobil, announced plans to double the company's shale oil production within a five-year timespan, a goal anticipated to materialize sooner.
On October 11, XOM unveiled its proposed $59.5 billion acquisition of Pioneer Natural Resources, representing one of the most substantial mergers ever seen in the oil industry. A successful merger would boost XOM’s domestic oil production to nearly double overnight, propelling it to the top among American producers. Furthermore, it could catalyze additional consolidation in this still-disjointed industry, potentially establishing American shale producers as the driving force of the global oil market.
But Why Shale?
The Permian Basin, between Texas and New Mexico, is an optimal opportunity for producers aiming to bolster their supply. According to the Federal Reserve Bank of Dallas, the Permian Basin provides about 40% of American oil production and 15% of its natural gas.
The renowned shale deposit boasts substantial infrastructure, is recognized for its high-yield productivity, and possesses significant untapped reserves that add to its appeal in the industry.
The shale industry has gradually transformed into a highly profitable venture in recent years. Enhancements in operational efficiency and a relentless focus on cost curtailment have eliminated wasteful methodologies.
According to JPMorgan Chase, the return on expenditures of American exploration and production, primarily shale-based, effectively produces double the oil volume it did in 2014. The sector’s enterprises have started producing methane, a potent greenhouse gas typically produced in tandem with shale oil.
This strategic shift first came due to regulatory enforcement and was later propelled by the commercial rationale as methane is a component of natural gas. Thus, its salvage not only makes environmental sense but also enhances profitability. Moreover, American shale's development process has proven to be faster, more affordable, and less carbon-intensive than conventional fields.
Major fracking companies have exhibited responsiveness to Wall Street’s appeals for enhanced returns over shale production hikes. The latest fiscal prudence endured during the oil price spike following Russia’s Ukraine invasion in February 2022.
The Acquisition and Its Impact
According to RBC Capital Markets analysts, Pioneer, the Permian oilfield's primary well operator, accounts for 9% of gross production, while XOM ranks fifth with 6%. Pioneer expanded its portfolio through significant acquisitions, such as shale rivals DoublePoint Energy for $6.4 billion in 2021 and Parsley Energy for $7.6 billion in 2020 under CEO Sheffield.
XOM's all-stock acquisition of Pioneer at $253 per share would catapult it to the top position in the largest U.S. oilfield, ensuring a decade of low-cost production. The merger marks XOM's most substantial acquisition since the $81 billion Mobil Oil procurement in 1999.
As of June 30, 2023, XOM maintained a robust cash reserve of approximately $30 billion. The company's decision to proceed with an all-stock deal offers a strategic advantage, significantly alleviating the potential fiscal pressure associated with debt-financed acquisitions. Moreover, when evaluated against its industry peers, XOM's balanced market valuation underscores the strategic prudence of an all-stock purchase.
The merger consolidates Pioneer’s 850,000 net acres in the Midland Basin with XOM’s 570,000 net acres across the Delaware and Midland Basins, creating an unprecedented high-quality undeveloped inventory posture in the U.S. unconventional industry.
The companies will have an estimated 16 billion barrels of oil equivalent resource in the Permian. Once the deal materializes, XOM’s Permian production volume is expected to more than double to 1.3 moebd, based on 2023 estimates and surge to about two moebd in 2027. The strategy involves increasing the output per well by fusing XOM’s technology with Pioneer's cost-effective production methods, which average approximately $10.50 per barrel.
XOM has a strategy of investing to raise production if the oil price and forecast profits are high enough. Rystad’s Alexandre Ramos-Peon, head of shale well research, anticipates the Permian Basin has another 15 to 20 years of high-quality drilling – which could convince XOM to ramp up output.
As XOM asserts, this transaction presents an opportunity for enhanced U.S. energy security by applying top technologies, operational excellence, and financial capability to a crucial domestic supply source and benefitting the American economy and its consumer base.
The deal, slated to close in 2024, would result in four of the largest U.S. oil firms dominating the Permian Basin shale field and its vast infrastructure. The size of this acquisition surpasses Shell's $53 billion BG Group acquisition in 2016, which positioned Shell at the forefront of the global LNG market.
Upon finalizing the sale, CEO Sheffield would receive a $29-million exit package while the other four top Pioneer executives will collectively earn about $42 million in severance payment. Pioneer shareholders will receive 2.3234 shares of XOM for each Pioneer share held.
Let's briefly delve into the key takeaways for investors from this potential acquisition:
Over the past two years, XOM has effectively transformed its financial stability, managing to rise from a period of significant losses and staggering debt. The recovery was accomplished by implementing cost reduction measures, asset liquidation, and capitalizing on escalating energy prices driven by global geopolitical turmoil.
Moreover, XOM's investments in renewable energy and strides toward environmental responsibility have yielded tangible results, evidenced by the record profit of $56 billion achieved two years after a deficit of around $22 billion precipitated by the COVID-19 pandemic.
Given its revitalized financial situation and solid operational foundations, XOM presents an enticing prospect for institutional investors. Notably, several institutions have recently modified their XOM stock holdings. Institutions hold roughly 60.5% of XOM shares. Of the 3,612 institutional holders, 1,564 have increased their positions in the stock. Moreover, 134 institutions have taken new positions (8,794,955 shares).
The oil giant's share price has recovered strongly since its early 2020 slump with plummeting oil and gas prices. It is trading at a surplus to the sector's earnings. Its forward non-GAAP P/E of 11.39x is 9.5% higher than the industry average of 10.40x. However, its forward EV/Sales multiple of 1.24 is 41.8% lower than the industry average of 2.15.
XOM fell short of market expectations and experienced challenges in financial performance in the last reported quarter. However, it remains resilient and focused on strategic initiatives to drive long-term growth and value creation.
Despite experiencing a dip from its record high of $120 following merger news, XOM’s shares now trade below their 100-day and 200-day moving averages of $108.53 and $109.83, respectively, showcasing a downtrend. However, Wall Street analysts expect the stock to reach $126.06 in the next 12 months, indicating a potential upside of 18.4%. The price target ranges from a low of $105 to a high of $150.
XOM anticipates higher crude oil prices to boost its upstream earnings by $900 million to $1.3 billion and higher natural gas prices to supplement $200 million to $600 million to its profits in the third quarter of 2023. This could enable the oil giant to report impressive results for the period, indicating its operating profits for the quarter to lie between $8.3 billion and $11.4 billion.
For the fiscal third quarter of 2023, analysts expect its revenue and EPS to come at $90.03 billion and $2.32, respectively. XOM topped consensus EPS estimates in three of the trailing four quarters.
Bottom Line
The announcement of the merger did not astonish many in the market. However, the essential query that lies ahead is the impact this deal will have on energy markets and whether it will serve as a profitable venture for XOM in the long haul.
Considering XOM's sluggish price trends and mixed analyst predictions and valuation, it could be wise to wait for a better entry point in the stock.
