Exxon Mobil (NYSE:XOM) has a problem. So does Chevron (NYSE:CVX), ConocoPhillips (NYSE:COP) and practically ever other major energy player.
The issue is a serious one that will need to be dealt with over the next few years. We’re not talking about huge debts, cash flow issues, legal hassles or even pending outrageous regulation.
No, we’re talking about falling oil output as legacy fields dry up.
Increasing output has become daunting task as myriad factors seem to conspiring against the majors. With all the “easy” oil found, resource nationalism rising and new reserves costing an arm-and-a-leg to tap, it’s easy to see why output and reserve replacement ratios has continued to drop for several countries over the last few years.
One remaining solution for many majors is to buy themselves some hefty, steadily producing reserves.
For investors, that opens up a door to profits.
A Looming Problem
Churning out consistent numbers of barrels of crude oil equivalents is the lifeblood of the industry. However, that has been increasingly difficult to achieve in the past few years. For instance, UBS (NYSE:UBS) analysts estimate that Exxon will see a 5.7% drop in its overall production in 2012.
There’s certainly justification for UBS’s dour warning.
According to its latest earnings report, XOM showed that its oil and gas output declined 7.5% to 3.96 million barrels oil equivalent per day. That’s nearly the fifth straight quarter of decline, and the longest period of declines in the last 13 years. Chevron reported its third quarter of production declines. Conoco and BP (NYSE:BP) have produced similar results; asset sales aside, the beleaguered British giant will see a 2.7% decline in its output.
Generally, when E&P firms can’t find oil quickly enough, they’re stuck with aging fields where overall output is declining — not good considering the current high-price oil environment. According to analysts, the average existing oil field has a depletion rate of 5% to 7% off their output per year.
Aside from that waning rate of production, the dwindling output rates that the majors are suffering are being caused by a complex mix of factors.
While “peak oil” can be debated all day and night, the truth is all the easy oil has been found. The idea of striking a gusher in the middle of a shallow field in Texas just isn’t going to fly anymore. That’s why we’ve seen an explosion of unconventional resources like shale and ultra-deepwater drilling.
However, tapping those assets are quite expensive and in some cases are currently above profit marks. With a fixed amount of CAPEX dollars to spend, E&P firms need to choose wisely what projects to undertake. Even then, the majority of new shale deposits or deepwater wells haven’t completely replaced the lost production.
Then there is the issue of increased resource nationalization. Energy investors in YPF (NYSE:YPF) and Argentina have found out the hard way what happens when the national government decides to come knocking … and that has caused oil majors to demure in several instances. After all, no one wants to spend $4 billion getting a field ready for production, only to have it taken away.
This laundry list of difficulties is exactly why the majors will have to break out their checkbooks and do some shopping.
Given the size and scope of the energy giants and their needs, it takes a certain kind of buyout that would provide enough of a direct boost to energy production, reserves and opportunities of scale to be worthwhile. E&P firms that have barely scratched the surface of their large resource potential are the perfect targets for the majors.
We’ve previously highlighted plenty of the opportunities in Canada here at InvestorPlace. Even with the CNOOC (NYSE:CEO) deal with Nexen (NYSE:NXY) deal up in the air, the region will continue to be a hotbed of M&A activity.
The same could be said for many U.S. names as well — especially those companies with large footholds in the best return plays like the Eagle Ford, Marcellus and Bakken.
Continental Resources (NYSE:CLR) and Whiting Petroleum (NYSE:WLL) remain firmly in the buyout potential category. Both feature relatively easy-to-swallow market caps — $13 billion and $5 billion, respectively. More importantly, the pair are the leading acreage holders in the shale oil-rich Bakken; those reserves continue to grow as well.
Continental reported a 57% increase in its estimations on what the formation holds after a well test. That well — nick-named SCOOP — could add as much as 1.8 billion barrels to Continental’s reserves over the next few years. That certainly fits into the size and scope required by the majors.
As for the Eagle Ford and Marcellus, Range Resources (NYSE:RRC) and EOG (NYSE:EOG) continue to hold vast acreage that produces a plethora of natural gas, shale oil and natural gas liquids. Although expensive, both remain quality buyout candidates for any supermajor.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.