Merger Mania Returns to Natural Gas

Dr. Kent Moors

Today we're going out into the Moroccan desert to evaluate shale gas fields here. It's early morning, and I am now awaiting my "ride."

They tell me his name is Saad, which means "happiness" in Arabic. Seems a strange name for what I'm still hoping is a Jeep.

Nonetheless, I have a few moments before he shows up to reflect on my government meetings in the capital city of Rabat.

This is an impressive city, with large areas of greenery and beautiful gardens. It also boasts one of the largest palace grounds I have ever seen.

Our meetings dealt with setting the legislative and regulatory agenda for shale gas development in the country. Morocco has been exploiting shale oil for more than a decade, but the gas is new. And it's creating some problems for the existing Oil Law.

If all goes according to schedule, the first evaluation wells will be spud over the next few months. That means there is little time left, before drilling starts, to establish the production, environmental, and royalty/profit ground rules.

One thing, however, is already apparent - both here and elsewhere internationally: Having a known volume of gas in the ground is one thing; being able to provide the working structure necessary to exploit it is quite another.

Without Infrastructure, Field Development Will Languish

Yesterday I traveled some 1,250 kilometers round trip, between Agadir in the south and the capital city of Rabat (north of Casablanca).

It's a 16-hour train ride, all told. But the trip would have been much more difficult only a year ago. That's because the new 250-kilometer extension of the motorway between Agadir and Marrakech is barely one year old.

I have seen this in countries throughout the world.

If there is no modern infrastructure, field development will languish. That infrastructure requires field-related investment (wellheads, processing facilities, gathering units, pipelines, compressors), as well as broader support (roads, communications, power, water availability and usage, among other things).

In short, some of this is going to come from the extracting companies, but the rest remains the responsibility of the government and Moroccan private sector.

Morocco certainly seems ready - provided the legal and regulatory structure is in place. Hence the main reason for my coming to the country in July. There is little time to pick this up once operations are in full swing (by the fall).

But there is another aspect rapidly developing here, and it comprises an immediate connection to what we are already seeing in the U.S. market.

Support and Transport M&A Is Heating Up

Even before the production facilities are in place, talk is beginning among likely outside companies about mergers and acquisitions (M&A) involving field supply, storage, and pipeline systems.

Given that most of these fields are some distance from population centers, the ability to provide for essential components will be decisive. Already, companies are calculating the net pricing for gas volume going to Europe (the primary consumer, after Morocco satisfies its own domestic market needs).

That will advance a wave of M&A here quickly - as we are, again, experiencing in the United States.

This is actually the main subject I want to address today.

We are witnessing a rapid acceleration of M&A in the United States. Unlike earlier waves of M&A activity, however, this is not primarily about extraction. The moves are in the support and transport sectors.

This is to be expected - for one fundamental reason: The volume of shale gas coming on the market is staggering. This year, North American producers (U.S. and Canada) could easily increase gas volume by more than 30%... in a single year!

Of course, dumping such volume on the market would cause a dramatic shift in the balance of supply and demand, with prices plummeting as a result.

In this environment, efficiency of operations may still refer to drilling per se. But these days, the ability of companies to realize profits, with the prospects of considerable available volume, depends on consolidating throughout the upstream-downstream sequence - not just in the fields.

Therefore, companies that control storage, processing, and transport facilities are primary takeover targets. And early identification of these likely targets can make for very profitable moves by average investors. More on that in a moment...

Probably the most prized asset class for acquisition is pipelines. The pipeline network in the United States and Canada is more than a venue for the transportation of gas.

The absolute majority of pipeline capacity is actually used for storage of excess volume. As a result, pipelines provide the main balancing act for a market that can easily become oversupplied.

Many of the companies of interest are diversified - made up of gathering, processing, truck, and retail distribution pipeline networks, as well as field operations.

Yet, if there is one conclusion emerging from what will be an increasing M&A feeding frenzy in natural gas, it is this: Operational efficiency requirements are moving acquisition strategies further from the field itself.
The midstream (gathering, processing, and throughput) is the emphasis now.

Some of these are privately held companies, so the retail investor has no access. But others are traded and have already experienced some consolidation.

The key to selecting the most likely profit moves is regional. Larger companies, utilizing an M&A plan to maximize the efficiency of their field operations, will need to acquire the assets that reduce the cost per volume of extraction. These certainly include pipeline, storage, and related facilities.

Here's what I suggest.

Take A Three-Step Approach

First, look at the expected volume anticipated from leased acreage by production companies. The companies will give you that information up front, in quarterly reports and other announcements.

Second, compare this volume with previous quarterly performances in shale basins by these same companies. That will indicate each company's additional midstream asset needs.

Third, assess the publicly traded companies that have assets available. These are always pipelines being of initial interest - processing and gathering secondary. Await indications of interest, and then buy into the shares of the likely target companies.

Using call options on these same companies is also a profitable way to participate in the increasing value, without committing to a longer-term holding strategy.

Back here, it is now 6 a.m. local time, and Ahmed, a field engineer from the company I am visiting today, is at my door. And he has a Jeep!

I tell him how thankful I am and ask him why he named the vehicle Saad. He laughs and says the Jeep is only for the first three hours of the journey into the desert. Saad is for the last hour or so.

Saad is a camel.

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Dr. Kent Moors

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Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.

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