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Exxon Buys Pioneer. Here's What Deal Could Come Next in the Energy Patch.

Motley Fool - Sun Oct 15, 2023

ExxonMobil(NYSE: XOM) made waves this week by agreeing to acquire Pioneer Natural Resources in a more than $60 billion deal. Many oil market watchers believe the deal will set off a consolidation wave.

Enterprise Products Partners(NYSE: EPD), Chevron(NYSE: CVX), and Permian Resources(NYSE: PR) stand out to a few contributors as companies that are likely to participate in the energy sector's upcoming merger wave. Here's how a merger could benefit these companies.

Enterprise has proved it'll buy its midstream peer

Reuben Gregg Brewer (Enterprise Products Partners): Energy producers aren't the only ones that are likely to see increased merger and acquisition activity. Enterprise Products Partners, for example, bought Navitas Midstream Partners in February 2022 for $3.2 billion. But that's just one of many acquisitions the master limited partnership (MLP) has accomplished in its history.

Midstream companies own large assets for which they charge customers usage fees. The model provides reliable cash flows to support large dividends. Enterprise's distribution yield is a hefty 7.3% and it is backed by 25 consecutive annual increases. However, the opportunity for building new pipelines and other energy infrastructure is limited because the best locations have largely been exploited. The easiest way to grow cash flow is likely to be buying midstream peers. With an investment grade-rated balance sheet and a $60 billion market cap, Enterprise is one of the strongest and largest players in the North American midstream sector. It has the wherewithal to keep doing deals.

What it gets, meanwhile, is increased scale in a business where scale confers advantages. Most obviously, the bigger it is the more able it will be to act as an industry consolidator. But it will also be able to spread its costs over more assets and perhaps gain additional leverage in negotiations with customers, thanks at least partly to the expansion of (and interconnections within) its asset footprint. Enterprise is prudent and probably won't go on a wild acquisition spree. But if it finds good assets at a good price, it has already proved willing to act. And in this case, the biggest benefit may actually go to the acquirer and its income-focused unitholders.

Exxon's biggest rival goes big

Matt DiLallo (Chevron): Oil giant Chevron has already completed one acquisition this year, buying PDC Energy for $7.6 billion. However, it's on the prowl for its next target. TheWall Street Journal recently reported that Chevron's CEO wants to do a big deal before he retires to set the company up for future growth.

The Journal also noted that Chevron had some interest in acquiring Occidental Petroleum(NYSE: OXY) earlier this year. That interest has reportedly faded, with Chevron moving on to smaller targets.

I wouldn't be surprised if Chevron circled back and eventually acquired Occidental. A tie-up between the two makes so much sense. Exxon's recent deal for Pioneer will make it the leading producer in the Permian Basin as it leapfrogs ahead of Occidental. However, a merger between Chevron and Occidental would give Chevron the lead in that crucial oil-rich basin.

On top of that, Occidental brings other assets to the table. It also has positions in the Rockies and the Gulf of Mexico, key areas for Chevron. Meanwhile, Occidental has international operations and a chemicals business, which also aligns with Chevron's globally integrated business model.

Occidental also has a growing low-carbon business, which aligns with Chevron's strategy. Acquiring the company, which is becoming a direct air capture technology leader, could accelerate Chevron's lower carbon energy ambitions.

Finally, there's some interesting history between these two companies. Occidental outbid Chevron to acquire Anadarko Petroleum in 2019. An acquisition of Occidental would enable Chevron to get the assets it originally wanted, plus Occidental's operations for less than the combined company was worth following its deal in 2019.

A merger of Chevron and Occidental Petroleum makes lots of strategic and financial sense. That's why I wouldn't be surprised if Exxon's acquisition of Pioneer drives Chevron to strike a deal for Occidental to one-up its rival.

An attractive play in the Permian

Neha Chamaria(Permian Resources): With ExxonMobil going all out in the Permian Basin by agreeing to acquire Pioneer Natural Resources in a historic deal, the Permian could see more deals and consolidation in the near future. The oil-and-gas-rich Permian Basin is vital to the U.S. economy, as it already accounts for nearly 40% of all oil produced in the U.S. and roughly 15% of the natural gas production in the U.S., according to the Federal Reserve Bank of Dallas.

The Delaware Basin within the shale patch, in particular, has a lot of potential, which is why a company like Permian Resources looks like the perfect next takeover target for oil majors. In fact, Permian Resources' latest move makes it lucrative like never before.

Permian Resources' operations are heavily concentrated in the Delaware Basin. The oil and gas producer took a big leap in August, when it agreed to acquire Earthstone Energy in an all-stock deal worth $4.5 billion. The deal will add nearly 223,000 net acres to Permian Resources' asset base in the Delaware and Midland basins.

Permian Resources expects the acquisition to boost its free cash flow (FCF) per share by more than 30% over the next two years and more than 25% over the next five- and 10-year periods. That should also give Permian Resources more leeway to boost shareholder returns since on top of a regular base dividend, the company expects to return 50% of its FCF remaining after the base dividend every quarter in the form of a variable dividend or share repurchases.

With its cash flows set to rise, Permian Resources could attract the attention of some of the largest Permian drillers like ExxonMobil and Occidental Petroleum.

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Matthew DiLallo has positions in Enterprise Products Partners. Neha Chamaria has no position in any of the stocks mentioned. Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Chevron, Enterprise Products Partners, Occidental Petroleum, and Pioneer Natural Resources. The Motley Fool has a disclosure policy.

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