Big Oil mega-deals would put investors on the spot

Pump jacks operate at sunset in an oil field in Midland
Pump jacks operate at sunset in an oil field in Midland, Texas, U.S. August 22, 2018. REUTERS/Nick Oxford

LONDON, Feb 2 (Reuters Breakingviews) - Exxon Mobil (XOM.N) and Chevron (CVX.N) are rolling in cash. So are Shell (SHEL.L), BP (BP.L) and TotalEnergies (TTEF.PA), but investors value U.S. oil majors way higher than European ones. That raises the question of whether Exxon or Chevron might undertake a transatlantic swoop.

The American duo’s valuation lead is tangible even though Shell’s 2022 results, released on Thursday, showed that earnings doubled year-on-year, matching those of its U.S. peers. $473 billion Exxon and $331 billion Chevron trade at 6 times expected EBITDA for 2023, twice the average of $210 billion Shell, $154 billion Total and $109 billion BP. One reason why is that as oil prices have soared, American drillers look more attractive than European ones that are also pressing into potentially lower-return renewable energy.

Imagine Chevron or Exxon acquired BP for $170 billion, factoring in a 30% premium to its market capitalisation, plus debt. The UK group’s forecast $19 billion of net operating profit after tax in 2023, as per Refinitiv data, would imply an 11% return on invested capital. That’s comfortably above BP’s cost of capital, which is probably around 9%. Citi analysts reckon such a merger could create cost synergies worth 10% of BP’s $37 billion of operating expenses. These would push the return to 13%. That sounds worth doing. Other combinations involving Shell yield lesser but still adequate returns.

Still, the financing would be tricky. If Exxon structured a BP swoop as a cash deal its net debt would shoot up from 5% of total capital to an uncomfortably high 39%. While BP’s gearing was itself around that level during the pandemic, the U.S. group’s investors might press for a more conservative share deal, or a blend of shares and cash. That would then raise a series of questions.

One is whether U.S. shareholders want the bother of a mega-deal in lieu of the huge buybacks and dividends they are currently trousering. Any cross-border deal would see Chevron’s Mike Wirth or Exxon’s Darren Woods take a big bet on continuing high oil prices, and also attract political heat. They might have to dispose of UK petrol station assets on competition grounds, and spin off BP or Shell’s solar and wind assets that form a part of Britain’s decarbonisation plans. While BP’s Gulf of Mexico assets should be attractive to a U.S. acquirer, other bits would be less so.

The other question is whether UK-based institutions want to hold paper in a U.S. driller less focused on building out renewables. Some of them are genuinely attracted by Shell, BP and Total’s vision of being stewards of the energy transition, and might therefore require a bigger deal premium, or reject an offer outright. But even BP boss Bernard Looney appears disappointed with some of the returns from low-carbon investments, according to the Wall Street Journal. And despite the European groups’ environmental ambitions, shareholders have not rewarded them with higher valuations, suggesting doubts that they can make a profitable transition away from fossil fuels. A U.S. offer might therefore be a test of investors’ own green bona fides.

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Shell delivered record earnings of $40 billion in 2022, the energy giant said on Feb. 2, more than double that of a year earlier.

Shell also posted record fourth-quarter profit of $9.8 billion on the back of a strong recovery in earnings from liquefied natural gas trading, beating analyst forecasts for an $8 billion profit. Shell shares were up 1.8% by 1019 GMT.

Earnings from the group’s LNG division reached $6 billion, a record high. As previously flagged, Shell boosted its dividend by 15% in the fourth quarter. The company also announced a new $4 billion share buyback programme over the next three months, unchanged from the previous three.

Separately, BP Chief Executive Bernard Looney plans to dial back elements of the oil giant’s high-profile push into renewable energy, people familiar with recent discussions said to the Wall Street Journal in an article published on Feb. 1. Looney has said he is disappointed in the returns from some of the company’s renewable investments and plans to pursue a narrower green energy strategy, the people said.

BP will report its fourth-quarter results on Feb. 7.

Editing by Neil Unmack and Oliver Taslic

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