The value of the mergers and acquisitions (M&A) market for US shale gas has increased with the emergence of the shales as a world scale source of secure, long-term supply. The most attractive plays offer robust economics, good access opportunities, and limited above-ground risk.

Despite increasing interest, the M&A market for shale gas does not appear to be overheated. Wood Mackenzie’s underlying valuation of recent deals suggests that buyers are factoring in long-term Henry Hub gas prices around US $6.50/Mcf; broadly in line with the company’s own gas price forecast.

Looking ahead, activity levels are set to remain high. While the land grab is largely over, the corporate landscape across the major resource holding basins – the Marcellus and Eagle Ford in particular – remains fragmented. Wood Mackenzie still sees significant opportunities for intra-play and sector-wide consolidation. Tighter deepwater regulation could accelerate the process. Companies looking to rebalance their portfolios post-Macondo might see shale gas as a more attractive and lower-risk option.

Shale Gas Dominates Onshore US M&A Activity

US shale gas has been a key theme in upstream M&A over recent years. During the first half of 2010, acquisition spend in the sector amounted to $21 billion, equivalent to approximately one-third of global upstream M&A expenditure. Through these deals, in excess of 35 Tcf of equivalent of shale gas resource changed hands at an average cost of $0.60/Mcf of equivalent.

The value of the market has increased with the emergence of shale gas as a world-scale source of secure, long-term gas supply. The key factor in driving this has been the continued evolution and application of new technologies to unlock enormous volumes that previously were considered subcommercial.

Resource

The magnitude of the US shale gas resource is extraordinary. Wood Mackenzie’s Unconventional Gas Service estimates the total resource potential of the 22 US shale plays currently covered at 650 Tcf of equivalent, equal to a resource life of 32 years based on total US gas production in 2009. Shale gas production is set to increase as a proportion of total US gas supply from 17% in 2010 to 35% by 2020.

Analysis incorporates all onshore Lower US 48-focused deals with a purchase price of more than $10 million, with the exception of the multiregion "mega-deals" by ConocoPhillips/Burlington Resources, Anadarko/Kerr-McGee, ChevronTexaco/Unocal and Suncor/Petro-Canada. ExxonMobil/XTO is classed as a shale gas-focused deal. (Charts courtesy of Wood Mackenzie M&A Service)

Economics

The continued evolution and application of new technologies has lowered development breakeven costs to a level at which the cost of shale gas is highly competitive with other domestic sources of supply (conventional and unconventional) and LNG imports. Operators have made, and continue to make, notable advances in reservoir modeling, pad drilling, horizontal drilling, specialized bits, and fracture stimulation treatments. Unit costs have fallen in spite of increasingly complex and specialized well design. Post-tax breakevens across the major resource holding basins range from $2.50/Mcf to $4.40/Mcf.

The focus of deal activity across the shales has evolved with the relative cost of supply for each play. In 2009, when the Marcellus Shale emerged as the new low-cost source of supply with the largest resource potential, investment swung firmly toward the Northeast. Historically, the Barnett Shale had been the main focus of activity, although other big shale plays – the Haynesville, Fayetteville, and Woodford – saw high levels of deal expenditure in 2008. Most recently, the Eagle Ford Shale has come to prominence. This liquids-rich play was proven in late 2009, and the first $1 billion-plus deals confirm its current status as the shale du jour.

The most attractive plays offer robust economics, good access opportunities, and limited above-ground risk. Recent large-scale deal activity has been dominated by the large caps and majors. In a wider upstream sector characterized by dwindling opportunities and increasing risks, the emergence of such an attractive resource – competitive with other global opportunities by every measure (scale, returns, and risk) – has been a game changer. What’s more, shale gas offers a good fit for this peer group; technical capability, financial strength, and a long-term view are prerequisites for those looking to build a material position.


Key benchmark shale gas deals with bubble size proportional to consideration.

What’s Driving Valuations?

The value ascribed to shale gas deals is largely a function of the stage of development, relative cost of supply, market access, and the quality and productivity of the acreage involved. With shale, not all plays and not all acreage are equal.

During the early stages in the evaluation of a play, deals tend to be priced on acreage costs. As confidence increases in the likely commerciality of the play, so does the cost of land. Once a play is established, US $/Mcf of equivalent metrics based on total resource estimates become increasingly meaningful. Given the relative immaturity of these plays, these metrics based on proved reserves are not relevant; deals involving assets at an advanced stage of development (only core sections of the Barnett would fit this description) are very unusual. Recent benchmark transactions have been priced at $0.20/Mcf of equivalent to $0.90/Mcf of equivalent on a total resource basis. Deals at the lower end of this spectrum generally relate to relatively immature plays (Reliance Industries Ltd./Pioneer Natural Resources Co. in the Eagle Ford, for example), while those at the upper end to the more established plays (Total E&P USA Inc./Chesapeake Energy Corp. in the Barnett, for example).

Sector Outlook

The ingredients required for continued high levels of M&A activity in US shale gas remain in place. The drivers that make shale gas so attractive – world scale resource, robust economics, access opportunities, and limited above-ground risk – are as strong as ever. The corporate landscape across the sector remains fragmented, with scope for intra-play and sector-wide consolidation. Potential acquirers, from domestic incumbents to overseas new entrants, continue to demonstrate a strong appetite for deal making.

Across the largest and most economically attractive shale plays, it is the North American large caps and smaller E&P companies that stand out as holding leading positions. The majors and overseas large caps, by contrast, still remain relatively underweight. While recent M&A activity has shifted the balance somewhat, the prevalence of partnership agreements dictates that existing players tend to retain a majority stake. The majors and large caps will continue to dominate large-scale deal activity in the sector.

Activity will continue to be directed toward the highest returning plays, with the Eagle Ford and Marcellus shales likely to remain the primary focus of attention in the near-term at least. However, with the possible exception of the Marcellus, access to the largest and most attractive plays is challenged by incumbent firms seeking to expand existing operations. For these companies, operational synergies will drive incremental deal economics. For new players, this perhaps increases the likelihood of larger corporate acquisitions as an entry mechanism.

A number of emerging trends are set to play an increasingly important role in shaping future M&A activity in US shale gas: a strategic shift in focus toward oil investment, driven by the continued disconnect between oil and gas prices and a depressed Henry Hub futures market; the emergence of new shale gas plays; the fulfilment of existing leasing commitments to drill up acreage; and the increasing inflow of private equity capital.

As low gas prices and increasing costs squeeze cash margins, there is mounting pressure on existing players to evaluate and restructure their portfolios. This currently is supporting liquidity in the asset market. Should the difficult environment persist, gas-weighted independents with weak balance sheets and/or hedging positions will look increasingly distressed and potentially vulnerable to takeover. Now, perhaps more than in the recent past, Wood Mackenzie sees a convergence of factors that could lead to significant consolidation across the shale gas sector.