Yesterday’s story about Venezuela opening the bidding for its oil resources raised an interesting question. What are the chances that Exxon Mobil Corporation (NYSE:XOM), with nearly $40 billion in cash at the end of the third quarter or Chevron Corporation (NYSE:CVX) with about $11 billion will acquire new assets or purchase smaller companies? Royal Dutch Shell plc (NYSE:RDS.A-B) is sitting on nearly $8 billion in cash, and BP plc (NYSE:BP) holds more than $6 billion.  If you have listened to what Big Oil operators have been saying, you can  assume that there is at least some interest in them looking at opportunistic acquisitions of companies, units, or reserve assets.

ConocoPhillips Corporation (NYSE:COP), though its market cap is near $75 billion, held more than $1 billion in cash at the end of the third quarter. Another substantial E&P player, Apache Corporation (NYSE:APA), has about $1.7 billion in cash and short-term equivalents.  Devon Energy Corporation (NYSE:DVN) has about $1.3 billion, and Anadarko Petroleum Corporation (NYSE:APC) has nearly $2 billion. 

What energy companies have right now that other industries might not have is at least a perceived ease of access or at least somewhat easier access to capital vie debt or equity sales.   

With the possible exception of Conoco, one could argue that this secondgroup offers likely targets for the big guys to go after. Each hasproved reserves at the end of  2007 in excess of 2 billion barrels ofoil equivalent. Conoco’s proved reserves totaled 8.72 billion barrelsof oil equivalent. There is no place on earth that Exxon or any of theother giants could get their hands on that much fossil fuel.

Apache’s market cap is about $25 billion, Devon’s is about $27 billion,and Anadarko’s about $18 billion. Any of these could be in Exxon’ssights, but would be a stretch for other potential buyers. Conoco maybe too rich for anyone on the surface.  Yet Warren Buffett bought in.

P/E ratios for Apache, Devon, and Anadarko are between 4.5 and about6.75. Conoco’s P/E ratio is just about 4. At the end of the thirdquarter, long-term debt for Apache and Devon was about $5 billion;Anadarko’s long-term debt was $11 billion. Conoco’s long-term debttotaled nearly $22 billion at the end of the third quarter.

What all these numbers add up to is that even at current valuations,the potential targets are in pretty good financial shape and wouldcommand a significant premium. The company with the weakest position is Anadarko, but its proved reserves at the end of 2007 of 1billion barrels of crude and 8.5 trillion cubic feet of natural gas areonly getting more valuable.

Big oil could take a pass on acquisitions, and choose instead to bid onnew projects in other parts of the world. Like Venezuela. Or Russia. OrNigeria. The prospects may be good in these places, but expropriationsand violence have chilled investment in these and other countries likethem.

There is, however, one place the big guys are definitely interested in:Iraq. As of January 2008, Iraq’s proved reserves totaled 115 billionbarrels of oil. Only about a quarter of that has been developed, andthe Iraqi government has been squabbling for a couple of years now onhow to monetize the resource. The big problem of course is security. Nooil company is going to make big investments in Iraq unless and untilthe shooting stops.

Other possibilities are that big oil could buy midstream assets likepipelines, gathering systems, and storage, or downstream assets likerefineries. Both are unlikely because the major oil companies havespent the last 15 years shedding these assets.

A more intriguing possibility is that big oil would make some seriousinvestments in alternative energy, either by acquiring existing publiccompanies or finding promising new start-ups to support. While such acourse of action might be intriguing and even desirable, it’s prettyunlikely to occur. Big oil companies need big projects in order togrow, and none of the existing alternative energy companies providesthat scale. And as for investing in new technology, big oil is unlikelyto place a major bet on a single, unproven idea. Far more likely isthat they’ll wait for products to hit the market and see who winsbefore acquiring anything.

We may have seen some recent added woes from refiners and we have been seeing a steady onslaught from analysts covering the oil patch.

In the end, a significant acquisition or two seems to be the mostlikely outcome. Even at an acquisition cost of more than $25/barrel forproved reserves, that’s cheap and safe if the barrels are mostly in andaround North America. The situation in Iraq could dictate when or ifany acquisitions occur. If the Iraqis adopt rules that are friendly tobig oil, and can solve the security issues, oil companies are verylikely to clamor for access to Iraqi deposits. It should be aninteresting year.

Paul Ausick
January 16, 2009

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