Opportunity in the middle ground for the oil industry

The international oil industry is structured like a badly made sandwich – two thick slices of bread with not much in the middle. Supermajors and national oil companies, with valuations in the hundreds of billions of dollars, form the top; hundreds of smaller companies the bottom. The current lack of strong, capable mid-sized companies is a historical aberration. Might it be about to change under the stress of lower oil prices?

The current lack of mid-sized multinational companies is a result of several trends over the past decade or so. The smaller majors – Mobil, Amoco, Arco and Phillips – had already merged with larger siblings around the turn of the century. In the early 2000s, flush with cash from rising prices but short of opportunities, the newly made supermajors and Asian national oil companies swallowed the last few large independents.

Lasmo, bought by Italy’s ENI in 2000, produced 200,000 barrels of oil equivalent per day (boepd); when acquired by Shell in 2002, Enterprise Oil was producing 245,000 boepd. The largest comparable company on the London market today, Tullow, extracts less than 80,000 boepd.

A number of London-listed firms, such as Cairn, Premier, Afren, Genel and the Dubai-based Dragon Oil have market capitalisations in the range of US$1 billion to $4bn, but there is then a huge gap up to BG, BP and Shell. Though more diverse, the mid-sized euro zone oil producers are usually appendages of larger groups – electricity utilities or chemicals firms.

And the North Americans, formerly significant overseas players, have largely gone home. Many, such as Devon and EnCana, sold off their international fields years ago, or, such as Talisman and Hess, are in the process of doing so. Even Apache and Occidental, two of the most successful internationally, are cutting their Middle East exposure on shareholder pressure.

The numerous medium to large corporations in the United States and Canada, such as Continental and Chesapeake, hold only domestic assets, mostly shale. Leading Australian companies such as Woodside, Santos, Oil Search and Origin have concentrated on a few massive liquefied natural gas projects.

Oil prices, until recently high and rising, kept the smaller players alive and prevented them being eaten up opportunistically. But for those at the bottom, life has been a struggle. They lack the capital and labour to drill the vast tracts of exploration acreage they have picked up around the globe.

This is not healthy. As in the US, the aggressive, faster-moving smaller companies have driven industry innovation and the exploration of new plays and resources. But minnows have bitten off more than they can chew in new Arctic and deepwater frontiers.

How could this change?

A few “super-independents” could emerge as the larger, cash-rich companies gobble up weaker competitors. Dragon has proposed a $789 million bid for Petroceltic, a company active in Algeria, Egypt and Iraqi Kurdistan.

The Africa specialist Ophir is looking to buy Salamander, which operates in South East Asia; it faces a rival approach from the Abu Dhabi-owned Spanish firm Cepsa. As the supermajors shed ageing North Sea assets, a large mature-field operator could grow. But until starved of cash, sellers’ expectations on oil prices may be unrealistic, making valuations hard to agree.

North American firms may come out of their insular mindset and look to rebuild their international portfolios – but there will first be a feeding frenzy at home as weaker oil prices force shale drillers to consolidate.

Or, a deep-pocketed Arabian Gulf buyer such as Mubadala, Ipic or Qatar Petroleum or Singapore’s Pavilion Energy could strategically invest to create a new mid-sized champion. This would need patience, top-quality management teams and the ability to choose good deals and then move fast.

Whatever happens, the industry needs to find the recipe for a healthy mid-cap sector. The alternative is not appetising – bankruptcies, layoffs and ultimately slower growth and missed opportunities.

Robin Mills is head of consulting at Manaar Energy and author of The Myth of the Oil Crisis

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