The large oil companies in the U.S. are making barrels of cash. And, unlike their European peers, they are spending little on renewable energy projects.
So how to put their record amount of cash to work? In the last four years, energy-focused investors have dumped stocks in oil companies that boost capital spending, favoring higher shareholder returns rather than spending on costly, long-term new projects.
Along with higher payouts for shareholders, another way to spend that gusher of cash is to snap up smaller rivals in the prolific Permian Basin.
ExxonMobil (XOM) had been hoarding cash this year after paying off the huge debt it ran up in 2020, during the COVID-19 oil price collapse. With net debt now at a mere $12 billion, Exxon has a lot of gas in its tank.
Cash increased at ExxonMobil by $22.9 billion in 2022, with free cash flow of $62.1 billion. Shareholder distributions were $29.8 billion, including $14.9 billion in dividends and $14.9 billion of share repurchases.
The company has now acted, as it is now engaged in talks to acquire Pioneer Natural Resources (PXD) for $60 billion. If the deal does go through, it would be Exxon’s largest since its landmark merger with Mobil in 1999.
What the Deal Means for Exxon
This proposed transaction should not have come as a surprise, since Exxon’s shareholders now prefer that the company use its share price and financial might to acquire existing oil and gas production, rather than spend on drilling that could take years to pay off (if it ever does).
Exxon Mobil is more than ready to pay up for production after missing its own output targets in the Permian basin. A deal would bring Exxon to about 1.33 million barrels of oil and gas per day. This would meet management’s target, set in 2019, to add 1 million barrels per day of oil production in the Permian by 2025. This target had more recently been pushed back to 2027.
Much of Pioneer’s acreage in the Permian Basin is situated next to Exxon’s, so a merger could allow for significant cost savings. Pioneer is the largest producer in the Basin, with 9% of gross production there, while Exxon is the fifth-largest at 6%, according to RBC Capital Markets. The Permian Basin produces about 5.8 million barrels of oil a day, out of about 13 million barrels per day in total U.S. oil production.
Exxon shares last month hit a record high of $120. And at 12 times next year’s earnings, based on S&P Capital IQ estimates, its stock trades at a premium of 33% to Pioneer’s. That gives Exxon a powerful currency to use in its pursuit of Pioneer.
A deal would not be Exxon's first or even its second in shale. It paid $36 billion to acquire XTO Energy in 2010 after missing the first phase of the U.S. shale revolution. In 2017, it followed that up with a $6.6 billion purchase to bulk up its Permian assets from the billionaire Bass family.
Now, a Pioneer acquisition would expand Exxon's Permian acreage position by about 84% to around 2 million acres. In effect, it would crown ExxonMobil the undisputed king of the Permian.
What the Deal Means for the Permian Sector
A transaction could also have an effect on the entire U.S. shale sector. It may turbocharge merger and acquisition activity in the shale patch, as other companies seek to match Exxon’s scale in the Permian.
The scramble for assets in the Permian Basin may end up rivaling the flurry of big oil deals in the late 1990s and early 2000s. During that time period, BP (BP) grabbed up Amoco and Arco, Chevron (CVX) took over Texaco, and Exxon combined with Mobil.
A very short list of possible targets for the large oil companies, all with assets in the Permian Basin, include the likes of Diamondback Energy (FANG), Permian Resources (PR), and Matador Resources (MTDR). Shares of each of these companies jumped by about 4% on the day Exxon’s interest in Pioneer became public, and have continued climbing.
Of these companies, I would choose Diamondback Energy over the rest.
Diamondback was a mid-sized oil and gas producer when it went public in 2012, but it has rapidly become one of the largest Permian-focused oil firms through a combination of organic growth as well as acquisitions - most recently, Firebird Energy and Lario Permian in 2022.
The company consistently ranks among the lowest-cost independent producers in the entire industry. And Morningstar says, “Because of its enviable Permian Basin acreage, Diamondback Energy is the lowest-cost producer in the upstream oil and gas segment.”
In addition, Diamondback has a stake in its mineral rights subsidiary, Viper Energy Partners (VNOM). This firm owns the mineral rights relating to some of Diamondback's most attractive acreage, further juicing returns on drilling for the parent.
Diamondback has also maintained a pristine balance sheet for most of its history. Its efforts around returning capital to shareholders is well thought-out, and include a fixed dividend, which it has increased over time. It plans to return 75% of its substantial future free cash flows to shareholders.
FANG is a buy in the $140 to $165 range.
