Low Oil Could Lead to Round of Energy Mergers

When oil prices hit a trough, history points to a likely energy industry response: mergers and acquisitions.

Price crashes in the early 1980s and late 1990s sparked a rash of deal-making that reshaped the industry. A decline in the mid-2000s led the giant firms to pick up smaller companies. Now, with oil's price down 40% since June, bankers and investors are hoping for a repeat.

Traders are betting on it: BP PLC shares jumped by close to 5% Tuesday after an anonymous Twitter user claimed rival Royal Dutch Shell PLC was going to make a bid. Spokesmen for BP and Shell declined to comment

The oil-field-services industry, which suffers when low prices reduce oil-company spending, have produced the first big deals this year with their clients cutting spending on production. Last month, the second-largest oil-field servicer, Halliburton Co., bid about $35 billion to acquire No. 3 Baker Hughes Inc. France's Technip SA also bid for a smaller services firm last month, offering $1.83 billion to buy Paris-based CGG SA.

Pascal Menges, a Lombard Odier manager whose funds hold shares of shale-focused U.S. energy companies, said he expects to see an uptick in acquisitions and asset sales if low oil prices continue. Low prices, he said, could put some small and medium-size companies into a "distressed situation" that forces them to either unload property to raise cash or sell out completely.

Past consolidations took place after a prolonged slump in crude prices and often during a period of weak energy-stock market valuations. In contrast, this year's crude price decline has lasted about six months.

Brent, the global oil benchmark, slipped to a four-year low Thursday after Saudi Arabia cut the price of its oil in the U.S. The price fell 28 cent to $69.64 a barrel on ICE Futures Europe.

Big deals among oil producers may be harder now than in the past because there are fewer large companies left, said Oppenheimer & Co. analyst Fadel Gheit.

The deep price drop of the late 1990s led to the consolidation of the so-called supermajors, the handful of huge, integrated oil-producing and refining companies that operate around the world. BP acquired Amoco and Arco, Exxon bought Mobil, and Chevron Corp. snared Texaco. That left the industry with about half-dozen big integrated players and a flock of much smaller companies that live and die on finding and producing new resources.

Since then, much of the industry's merger activity has involved big companies buying smaller companies to gain access to new energy sources, or in some cases companies shedding exploration assets or businesses that drag on profits. Shell, for example, has sold oil fields in Nigeria, while U.S.-based Hess Corp. has gotten rid of assets related to refining.

Overall, oil and gas deals have slowed over the past few years, according to data from researcher Dealogic, as big oil companies have come under pressure to reduce spending. The $242 billion in deals globally in 2013 was the lowest since 2009, Dealogic said. This year activity is up with nearly $300 billion in announced deals so far.

Now, London investment bankers--who handle a large portion of global oil transactions--say such deals are likely to pick up again. Dropping oil prices have slashed the value of smaller exploration and production companies, giving some a market capitalization less than the value of their assets. London-based Ophir Energy PLC, for example, has a market value of about $1.25 billion, less than the $1.49 billion in its cash holdings at the end of June.

Some of those companies see deals as a way to survive the downturn. Ophir agreed last month to buy rival Salamander Energy PLC for less than $500 million. An Ophir spokeswoman said the deal hasn't closed yet.

When it comes to bigger mergers, bankers say, companies must first decide the market is predictable enough to start making long-term decisions. buyers want to see if prices keep falling before committing, while sellers are trying to avoid selling when the market is at a low.

Viswas Raghavan, head of banking for Europe, the Middle East and Africa at J.P. Morgan Chase & Co., said there hasn't been a lot of deals in the energy sector yet because "a lot of these developments have happened very quickly." He added, "If you're in that sector, you're caught in the same valuation downdraft."

Mr. Raghavan said he expects deals between companies that have real synergies. "Opportunism does play a part but it can't be the driver."

Since many small oil companies still need cash, and large ones need resources to replenish their reserves, "you'd be more likely to see bits and pieces getting sold," another banker said. For example, India's ONGC Videsh Ltd. has been talking to Tullow Oil PLC about buying some assets.

Energy bankers said it is still possible to see a return of the megamerger. Even after the last wave of giant deals a decade and a half ago, Shell talked internally and with bankers about merging with BP and BG Group PLC, said people involved in those talks. Such big deals are complicated, but also offer the most potential upside, said Oppenheimer's Mr. Gheit, because of potentially huge economies of scale.

Several bankers say BG, which owns stakes in oil and gas fields from Brazil to the North Sea, could be a target for a large company looking to make get larger. BG, valued at around $50 billion, is about one-eighth the size of ExxonMobil but far larger than most exploration and production companies. Its shares are currently trading at their lowest level for five years.

But the company recently hired a new chief executive and buying the company outright would still be a large deal for any would-be acquirer. BG said it doesn't comment on market speculation.