Permian M&A Has Plenty of Room to Run. Expect More Oil Consolidation.

The Permian stretches from part of Texas into New Mexico. Production there has tripled since 2016 to about six million barrels a day today. That makes the Permian responsible for about half of U.S. oil output and nearly 6% of global supply. And while Saudi Arabia and its oil-producing allies in OPEC+ have been constraining production, U.S. exports of about 4.5 million barrels a day are satiating global demand.

Permian production growth should slow, but the basin will remain the pre-eminent oil source in the U.S. Its reliability and low-cost structure has attracted oil majors, including

Exxon Mobil

and

Chevron
,

and spawned billions-worth of M&A. 

Shale drilling originally started with small, independent players. Exxon’s announcement in October that it was buying one of the early drillers,

Pioneer Natural Resources
,

for $64.5 billion was a milestone for the region. It will give the oil major prime acreage and puts a spotlight on the companies that have yet to merge. 

Even accounting for the recent buying spree, there are still quite a few companies with Permian acreage, including many tiny, lesser-known operators. Analysts expect the industry to pause while it digests a recent flurry of deals, but it will soon resume making acquisitions, creating bigger and bigger companies.

Data from analytics firm Enverus indicate the recent oil-merger announcements will change the landscape. Assuming they are successfully completed, the deals will put half the production in the basin in the hands of just a half-dozen producers, based on last year’s drilling numbers. Output of the largest top 25 Permian producers ranges from an estimated 850,000 barrels a day from a postmerger Exxon-Pioneer to about 38,000 from Franklin Mountain Energy.

In-between is a middle tier of players that analysts expect could merge, cementing the majors’ control of the region.

“Eventually in the Permian, you’re going to have two, three, maybe four [major] operators at most,” said Simon Wong, portfolio manager at Gabelli Funds.  

These mergers are driven by the power of scale and cost synergies in oil production. Energy companies have been under pressure to return cash to investors and keep a tight rein on capital spending. Managements see buying companies with good Permian acreage as a quick way to efficiently add more barrels of output and streamline costs. 

But production costs are already declining even with transactions still pending.  

“Over the last year, it would appear that the overall cost structure of the shale industry went down by 10%. That’s a function of productivity gains, including rig utilization,” said Ed Morse, senior advisor at Hartree Partners. He based that calculation on the shale-oil production by publicly traded companies in the Permian and other U.S. shale plays, such as the Bakken in North Dakota. 

Crude prices

have hovered below $80 in recent trading. All things equal, the oil-driven mergers could be a slight positive for crude prices, but analysts say it’s difficult to project with so many factors at work. 

“When these companies merge, it’s not necessarily one plus one equals three in terms of development plans. They’re all cutting rigs, they’re cutting track crews,” said Timm Schneider, founder and CEO of Schneider Capital Group. They are effectively controlling supply. “On the margin, that’s constructive for oil prices.” 

Wong agrees that the mergers could result in upward pressure on oil prices. Smaller companies are typically less disciplined when it comes to capital allocation and drilling. “If you look at the last couple of mergers that have been announced, they’re planning to cut back on drilling, and completion [of wells] so…