Exxon/Pioneer: rising interest rates and nervous investors force shale consolidation

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Who will fund innovation in energy exploration and production? It is a fair question this week after ExxonMobil confirmed an all-share purchase of Pioneer Natural Resources. The deal will total $64.5bn in enterprise value, on an 18 per cent premium.

Known for its acreage in the oil-rich Permian Basin of Texas, Pioneer (and other independent wildcatters) perfected “fracking” to extract oil and gas in the US. The cash flows never quite matched the hype. But fracking did make the country a leading global producer and exporter of fossil fuels.

Antsy shareholders and elevated interest rates have left shale drillers such as Pioneer out of favour. Exxon says its integrated model of oil extraction and refining uniquely gives it the scale to squeeze out costs.

In recent years, Pioneer and its explorer peers have slashed capital spending, diverting cash flow to pay for dividends and buybacks. Still, Wall Street analysts estimate that of a $9bn of forecasted cash flow from operations in 2024, half will go to capital expenditures. That same proportion at Exxon should be less than 40 per cent.

Even as Pioneer has committed 75 per cent of cash flow post capex to shareholders, its shares trade cheaply. The buyout price values Pioneer shares at just 12 times forward earnings, relatively low historically.

Exxon will pay with its own shares trading also at 12 times. Its bonds due in 2030 trade at a yield of just over 5 per cent. But given that the company is A rated, with only $40bn of existing debt, using equity rather than cash makes good sense.

Exxon has calculated that giving up just over a tenth of its overall shares outstanding is worthwhile. This enables it to gather a chunk of Permian real estate, the associated cash flows and what it estimates as $2bn of annual synergies. The bulk will come from “improved resource recovery”.

That boasts of its capabilities of removing resources from the ground cheaply rather than any exploration revolution. Investors should approve.