The competition between Occidental Petroleum Corp. and Chevron Corp. to acquire Anadarko, a large independent oil and gas producer headquartered near Houston, has captivated the business media in recent days.
Warren Buffett disrupted the dynamics over the weekend by offering to invest $10 billion in Occidental preferred stock — but only if they win the bid.
{mosads}This might sound like another big Wall Street transaction where numbers in the tens of billions of dollars almost seem routine, and the corporate players are interchangeable.
But there are some interesting factors oil and gas industry stakeholders know are at play here, and these factors will determine further deals down the road.
The first is that the U.S. has achieved energy security because of the “shale play,” especially in the oil resources in West Texas and southeast New Mexico, supplemented by the deepwater Gulf of Mexico.
We have become the largest oil producer in the world and a net exporter. Additionally, the associated natural gas has put us in the position of exporting liquefied natural gas (LNG), instead of importing it.
Initially, at the start of the shale revolution over a decade ago, small independent companies focused on applying and improving new technology that combined horizontal drilling with hydraulic fracturing to produce new oil from old, seemingly depleted fields.
Those small players tried to acquire as much acreage as possible. Investors went along with that strategy, even though cash flows were illusory.
The major international companies had a mixed record as the revolution got underway. Shell and BHP of Australia struggled to match the flexibility of the small independents and took heavy losses. ExxonMobil made an early big play by acquiring a company called XTO for about $40 billion.
Occidental, which has a long history in the Middle East, Anadarko, which possesses assets in Africa and Latin America, and Chevron, which holds a worldwide portfolio of assets, shifted capital budgets back home.
Recently, both ExxonMobil and Chevron announced goals to produce more than 1 million barrels per day from the Permian Basin. That’s a lot even for big companies.
Second, investor sentiment has shifted away from energy companies over the past year or so. They became disenchanted with growth that didn’t produce profits, cash flow or return of investment.
The volatility of oil prices, fluctuating by 40 percent just since the first of the year, added to the challenge to value companies in the industry. Trying to assess what the Organization of Petroleum Exporting Countries (OPEC) and Russia would do in response to increasing U.S. production was at best challenging.
But companies in the industry felt they could see value and deal with challenges that portfolio investors did not. This led Chevron to offer a nearly 40-percent premium for Anadarko, only to see Occidental counter with a more generous offer.
Buffett, who had shunned the industry, spotted opportunity. With a war chest of more than $100 billion, his $10 billion adds heft to Occidental’s bid — but at a high cost.
Occidental will have to pay Berkshire Hathaway $800 million per year for at least 10 years. And Buffett’s organization also negotiated the right to acquire up to 80 million shares of common stock at $62.50 per share, just above the current market value.
Corporate governance issues have emerged in the early stages of the battle. Anadarko repeatedly turned down proposals by Occidental’s CEO to acquire the company, choosing instead to accept an offer from Chevron, even agreeing to pay Chevron about $1 billion if the deal broke up.
Occidental countered with an even larger offer before Buffett entered the picture. One stated explanation for Occidental’s decision to accept his offer is that the firm would need to sell fewer new shares (using Berkshire Hathaway cash), and it would not be required to get approval from its shareholders to consummate the deal. This has caused an uproar by some institutional and individual investors.
Chevron has been at this juncture before. Almost 15 years ago, Chevron acquired Unocal after a bruising battle with the China National Offshore Oil Company (CNOOC). Chevron had to use its political and financial muscle, but it ultimately won with a lower bid than CNOOC offered.
The Unocal board chose Chevron because they were convinced that the deal would face few hurdles and could be completed promptly.
{mossecondads}Chevron has not responded to the new developments except to say that it feels its offer is best for Anadarko shareholders. Anadarko’s board and shareholders will have to choose between two offers that differ in stated value and structure. Occidental offers a higher stated value and more cash; Chevron offers more stock.
In an age when institutional investors have broad reach, many of them do not own just Anadarko, Chevron, Occidental or Berkshire Hathaway stocks; they may be invested in two companies — or even all four.
Therefore, they need to consider the medium-term implications of the deal for the winning bidder. Will Occidental have to sell off assets or assume more debt? Which company can achieve the greatest financial synergies (slashing corporate overhead) and operational efficiency in the Permian Basin? What happens to Anadarko’s huge LNG project in Mozambique that requires billions of dollars to build out?
Stay tuned for critical developments in the days ahead — the involved companies’ thousands of employees in Houston certainly are.
Bill Arnold is a professor in the practice of energy management at Rice University’s Jones Graduate School of Business. Previously, Arnold was Royal Dutch Shell’s Washington director of international government relations and senior counsel for the Middle East, Latin America, and North Africa.