The Rabid Capitalist

Professor Glenn A. Okun

Yesterday, ConocoPhillips agreed to acquire Marathon Oil in an all-stock transaction valued at $17.1 billion.  This was the latest step in the consolidation of the oil and gas industry previously described by The Rabid Capitalist (see https://therabidcapitalist.com/2024/02/19/oil-prices-will-rise-courtesy-of-consolidation/).  A few major oil and gas firms, including Exxon, Chevron and Occidental, will substantially control the domestic supply, creating highly attractive shareholder value as a consequence of implementing the ultimate roll-up strategy.

The roll-up strategy has been a staple of private equity and American business.  Shareholder value is generated through completing accretive acquisitions, capturing cost efficiencies and driving revenue growth. 

Accretive acquisitions.

Majors have completed a number of accretive acquisitions in which earnings per share grew as a result of the merger on a fully diluted basis.  Acquirors have been exploiting their valuation multiples to buy firms trading at lower multiples, thereby capturing earnings inexpensively. 

Cost efficiencies.

The acquirers have consistently described the cost savings available post-closing.  There are natural economies of scale to operating adjacent and proximate oil and gas properties.  These are low risk margin expansion opportunities. 

Revenue growth.

Revenue growth will be generated by virtue of the consequence of consolidation reducing competition.  The smaller number of competitors have the chance to create a more orderly oil and gas domestic market.  The orderly market is one in which attractive pricing, and revenues, result from constructively organized competition controlling supply. 

Price discipline is assured in the future.  The majors’ goal of margin expansion requires them to maximize the price, not production volumes, of oil.  Consolidation eliminates the margin compression caused by independent oil producers in the past. The private oil producers of the Permian Basin that flooded the market with oil when prices increased are becoming subsidiaries of the majors. 

Pricing power will become a consequence of this industry roll-up.  It will be the result of reorganizing competition.  Oil prices will rise over time as a result.  When these transactions close, less than ten companies will own more than half of daily oil production in the United States. 

The long-term price forecast for oil will benefit as a result.  Global oil and natural gas prices will become the result of decisions made by two cartel-like entities.  OPEC, and OPEC plus, will set international prices by collective decision-making.  The domestic majors, having become a de facto cartel, will control domestic prices by virtue of constructive competition. 

The ultimate roll-up.

The consolidation of the oil and gas industry is the ultimate roll-up because it has unusually low risk relative to the typical execution of this strategy.  Unlike the common implementation of the roll-up where the consolidator has to defeat opponents in order to successfully capture margin expansion and revenue growth rewards, the strategy is free of this risk in this case because it is being implemented by many large players, guaranteeing its success.

Collusion or other forms of illegal competition are not required in order to achieve the roll-up’s margin and revenue goals.  Price maximization is easily achieved through rationalization of capital investment in exploration and development and the implementation of disciplined production goals if execution merely requires firms to observe the actions of a few large visible competitors.

Oil and gas majors, especially those that are part of our portfolio, will benefit greatly.  Investors will as well.  The consolidators have become shareholder-friendly companies.  They have committed to providing stockholders with attractive dividends and sizable share repurchases.  Revenue and margin growth will deliver shareholder value through capital appreciation as well.

The investment case for the oil and gas majors portfolio (XOM, BP, SHEL and TTE) has grown in attractiveness by virtue of the long-term effects of industry consolidation.  The Rabid Capitalist’s long-term investment strategy remains intact.

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