Momentum builds in oil & gas sector as drilling increases

Technology innovators especially attractive as M&A targets

Oil & gas activity rose during the first quarter in Texas, Louisiana and southern New Mexico, according to energy executives responding to the quarterly Federal Reserve Bank of Dallas Energy Survey — news that bodes well for M&A activity in the oilfield services sector.

Service companies that made it through the downturn are ramping back up and becoming more attractive as merger and acquisition targets, based on the rates they can charge. Those that are innovating with new technology are especially attractive to private equity funds that see these companies on the cutting edge of future oil production.

The Fed’s 11th District business activity index — a broad measure of conditions for energy firms — rose to 41.8 from 40.1 in the first quarter. Positive readings generally indicate expansion, while readings below zero indicate contraction. The 11th district, based in Dallas, covers a region that includes Texas, southern New Mexico and northern Louisiana and includes the nation’s largest oil patch — the Permian Basin in West Texas.

It doesn’t, however, include the newsworthy Scoop and Stack plays in Oklahoma, where a lot of activity is underway. In late March, Newfield Exploration Co. reported an oil well in Oklahoma’s Stack Play in the Anadarko Basin set a record with a 24-hour flow rate of 2,931 barrels of oil equivalent per day and a record 20-day average oil production rate for the Scoop and Stack plays. Private equity firms are keeping close tabs on these plays and looking for opportunities to invest. Marathon Oil bought $888 million worth of assets in the Stack last year and intends to spend $700 million drilling there this year.

Private equity funds and others in the M&A space are also very interested in companies operating in the Permian Basin, where more than 300 rigs now in operation indicate that a rebound is firmly underway. In fact, the U.S. could be poised for record-breaking U.S. oil production by next year.

The Fed’s energy survey results correspond to what we are hearing and seeing from oilfield services clients who say rates they are charging are up 15% to 25% over prices charged in the trough of the bust. More than half of respondents who drill, complete or work on wells expect selling prices for those services to increase this year, according to the survey. Responses for other types of services were mixed, with many predicting no change in prices.

We believe PE funds and others with money to deploy will be interested in oilfield service companies that continue to innovate with new technology and efficiencies that drop the break-even oil prices needed to profitably drill a new well. The Fed survey notes those prices are now between $46 and $55 per barrel depending on the region, down about 6% over last year.

Technological innovations and automation in the area of operational intelligence, for example, have resulted in a decline in the number of workers a driller needs on site, which saves labor costs. These and other innovations should continue to drop break-even prices going forward while raising interest in M&A deals for innovative service companies.

Oilfield services anticipate the outlook for the oil patch will continue to improve over the next six months, the Fed survey noted, and we agree. Nearly 70 percent of oilfield services firms reported an improved outlook in the survey.

Capital Alliance Corporation is a Dallas-based investment banking firm with an extensive international reach and a 40-year history of providing trustworthy advice to private company shareholders who want to sell their businesses. Our team has deep operational and M&A experience across many sectors, including energy.