Amidst the backdrop of U.S. oil giants enjoying significant profits while allocating minimal resources to renewable energy endeavors, a pressing question arises: How can these cash-rich companies make the best use of their substantial reserves? In recent years, energy-focused investors have been favoring oil firms that prioritize higher returns for shareholders over capital expenditures on lengthy, costly projects.
One intriguing avenue for deploying their ample cash reserves lies in the acquisition of smaller rivals operating in the prolific Permian Basin. ExxonMobil (NYSE:XOM), which had been conserving cash following the debt incurred during the 2020 COVID-19 oil price collapse, is now well-positioned to make strategic moves. With a mere $12 billion in net debt and a substantial influx of cash, Exxon is actively engaged in talks to acquire Pioneer Natural Resources (NYSE:PXD) for a monumental $60 billion, potentially marking its most significant deal since its merger with Mobil in 1999.
This proposed acquisition aligns with a growing preference among Exxon’s shareholders for the company to utilize its financial strength to acquire existing oil and gas production assets rather than invest in long-term drilling projects. Exxon Mobil aims to secure its production targets in the Permian Basin after previously missing its output goals. If the deal proceeds, Exxon could increase its daily oil and gas production to approximately 1.33 million barrels, fulfilling its management’s 2019 goal to add 1 million barrels per day of oil production in the Permian by 2025, a target that had recently been pushed back to 2027.
Pioneer’s acreage in the Permian Basin significantly overlaps with Exxon’s holdings, offering potential cost-saving synergies. Pioneer, as the largest producer in the Basin with 9% of gross production, complements Exxon, the fifth-largest producer at 6%, according to RBC Capital Markets. The Permian Basin contributes approximately 5.8 million barrels of oil daily to the total U.S. oil production of about 13 million barrels per day.
Exxon’s stock price has reached record highs, reaching $120 per share. At 12 times next year’s earnings, based on S&P Capital IQ estimates, Exxon’s stock trades at a 33% premium over Pioneer’s, providing Exxon with significant leverage in its pursuit of Pioneer.
This potential deal underscores Exxon’s commitment to strengthening its position in shale. Previously, the company acquired XTO Energy for $36 billion in 2010 and expanded its Permian assets through a $6.6 billion purchase from the Bass family in 2017. If this acquisition materializes, Exxon’s Permian acreage would grow by approximately 84%, establishing ExxonMobil as a dominant force in the Permian Basin.
The ripple effect of such a transaction could be felt across the entire U.S. shale sector, potentially igniting a surge in merger and acquisition activity as other companies strive to match Exxon’s Permian scale. The Permian Basin may witness a rush for assets akin to the major oil deals of the late 1990s and early 2000s, which saw BP acquiring Amoco and Arco, Chevron taking over Texaco, and Exxon merging with Mobil.
Several likely targets for larger oil companies with Permian Basin assets include Diamondback Energy (NASDAQ:FANG), Permian Resources (NYSE:PR), and Matador Resources (NYSE:MTDR). Following the revelation of Exxon’s interest in Pioneer, the stock prices of these companies surged by approximately 4% and have continued to rise.
Among these potential targets, Diamondback Energy stands out. It has rapidly grown to become one of the largest Permian-focused oil firms through a combination of organic expansion and strategic acquisitions. The company is renowned for its cost-efficiency and boasts the lowest production costs among independent upstream oil and gas producers. Additionally, Diamondback’s mineral rights subsidiary, Viper Energy Partners (NASDAQ:VNOM), owns mineral rights related to some of its prime acreage, enhancing returns on drilling activities.
Diamondback has maintained a robust balance sheet, with a well-thought-out capital return strategy, including a steadily increasing fixed dividend. The company plans to return 75% of future free cash flows to shareholders.
In summary, Diamondback Energy presents a compelling investment opportunity in the range of $140 to $165 per share amidst the backdrop of potential industry consolidation and increased focus on Permian Basin assets.
Featured Image: Unsplash
