Release date: November 2, 2016  |  Next release date: November 9, 2016

Stable oil prices, improving credit conditions contributing to rise in merger and acquisition activity

Exploration and production (E&P) companies are increasing merger and acquisition (M&A) spending in the United States as stable crude oil prices and improved credit conditions in recent months allowed some companies to purchase assets or entire companies. The increase in M&A spending also suggests improved investor sentiment in the oil industry. The deals are concentrated in the Permian region of the United States, the area where the most drilling rigs have been deployed recently. The Permian is also the only onshore area where production is expected to increase in the next few months.

The second half of 2016 through November 1 already has more M&A spending than the first half of 2016, but on fewer deals. The 93 M&A announcements in the third quarter of 2016 totaled $16.6 billion, for an average of $179 million per deal, the largest per deal average since the third quarter of 2014 (Figure 1). Of the 71 deals valued at $1 billion or more since 2011, nine occurred in the third and fourth quarters of 2016 (to date), compared with only four in all of 2015. Several of these larger deals involved assets in the Permian Basin. Deals in the Permian Basin accounted for more than half of total deal value in the fourth quarter to date on only six of 28 deals.

Some notable announcements include

• EOG Resources announced on September 6 that it will acquire Yates Petroleum for $2.5 billion, doubling its acreage in the Delaware Basin, part of the Permian Basin area.
• On October 13, RSP Permian announced it will acquire Silver Hill Energy Partners and Silver Hill E&P for $2.4 billion.
• On October 18, SM Energy announced it will sell $785 million in Williston Basin assets in the Bakken region and spend $1.6 billion through cash and shares to acquire 35,700 net Permian Basin acres in the Midland Basin from QStar LLC.
• Just over two months before this announcement, SM Energy acquired 24,783 net Permian Basin acres in Howard County, Texas, in its $980 million purchase of Rock Oil Holdings.

M&A activity includes the sale of assets from one entity to another, which does not necessarily lead to an increase in E&P investment or production. A company may engage in M&A to diversify its portfolio or to position itself for future opportunities. A different company may sell property to increase liquid assets on its balance sheet. Continued increases in the U.S. rig count, however, suggest companies are beginning to invest capital in E&P projects. Most increases in rigs over the past six months occurred in the Permian, which now holds nearly as many active rigs as the rest of the United States combined, including both on- and offshore rigs (Figure 2). The Permian is the only region in the Energy Information Administration’s (EIA) Drilling Productivity Report where oil production is expected to increase in October and November.

Two related factors likely contributing to increased M&A are an increase in crude oil prices and a reduction in credit spreads (Figure 3). On October 19, West Texas Intermediate (WTI) crude oil prices closed at $51.60 per barrel (b), the highest level since July 2015 and nearly twice the recent low point of $26.21/b reached in February 2016. Since October 19, prices have fallen by about $6/b, but remain well above early-year lows. The option-adjusted spread of high yield energy bonds to U.S. Treasury bonds, a measure of default risk, declined since oil prices bottomed and is now at the same level it was in November 2014, when oil prices were above $70/b. Credit spreads declined nearly 50% compared with October 2015, when prices were in the same $45/b-$50/b range. Improved credit conditions in the energy industry lowers the cost of borrowing and allows many companies to issue equity to increase liquidity in their balance sheets or make opportunistic purchases. Companies that defaulted on a bond or were upgraded to investment grade standing are removed from the Bloomberg High Yield Corporate Bond Index over time.

Continued M&A and investment could lead to an increase in Lower 48 states crude oil production, consistent with EIA forecasts that increased production will occur in the second quarter of 2017. However, this production forecast is predicated on the WTI price forecast in the EIA's October Short-Term Energy Outlook (STEO), which is highly uncertain. Significant divergence of actual prices from the projected path could change the pace of new-well drilling, which would in turn affect the production forecast.

U.S. average regular gasoline retail price decreases, diesel fuel price remains unchanged

The U.S. average regular gasoline retail price dropped one cent from the previous week to $2.23 per gallon on October 31, up one cent from the same time last year. The Midwest price dropped three cents to $2.08 per gallon, while the East Coast and Gulf Coast prices each fell one cent to $2.22 per gallon and $2.04 per gallon, respectively. The West Coast price increased two cents to $2.70 per gallon, and the Rocky Mountain price increased less than one cent, remaining at $2.29 per gallon.

The U.S. average diesel fuel price remained virtually unchanged at $2.48 per gallon, down one cent from the same time last year. The West Coast price increased two cents to $2.77 per gallon, while the East Coast price increased one cent to $2.48 per gallon. The Rocky Mountain and Midwest prices each fell one cent to $2.54 per gallon and $2.44 per gallon, respectively. The Gulf Coast price remained unchanged at $2.35 per gallon.

Propane inventories gain

U.S. propane stocks increased by 0.3 million barrels last week to 100.9 million barrels as of October 28, 2016, 1.5 million barrels (1.5%) lower than a year ago. Gulf Coast inventories increased by 0.2 million barrels, while Rocky Mountain/West Coast inventories and East Coast inventories each increased by 0.1 million barrels. Midwest inventories decreased by 0.1 million barrels. Propylene non-fuel-use inventories represented 3.7% of total propane inventories.

Residential heating oil price increases, propane price decreases

As of October 31, 2016, residential heating oil prices averaged $2.40 per gallon, less than one cent per gallon more than last week but nearly three cents per gallon less than last year at this time. The average wholesale heating oil price is $1.61 per gallon, nearly three cents per gallon less than last week and just under a cent per gallon less than a year ago.

Residential propane prices averaged $2.06 per gallon, one cent per gallon less than last week but almost 14 cents per gallon more than one year ago. Wholesale propane prices averaged nearly 69 cents per gallon, one cent per gallon lower than last week but nearly 15 cents per gallon more than last year's price.

For questions about This Week in Petroleum, contact the Petroleum Markets Team at 202-586-4522.

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Retail prices (dollars per gallon)

	Retail prices	Change from last
	10/31/16	Week	Year
Gasoline	2.230	-0.013	0.006
Diesel	2.479	0.001	-0.006
Heating Oil	2.399	0.005	-0.026
Propane	2.060	-0.009	0.136

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Futures prices (dollars per gallon*)

	Futures prices	Change from last
	10/28/16	Week	Year
Crude oil	48.70	-2.15	2.11
Gasoline	1.469	-0.062	0.064
Heating oil	1.542	-0.032	0.043
*Note: Crude oil price in dollars per barrel.

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Stocks (million barrels)

	Stocks	Change from last
	10/28/16	Week	Year
Crude oil	482.6	14.4	31.7
Gasoline	223.8	-2.2	8.5
Distillate	150.6	-1.8	9.8
Propane	100.913	0.346	-1.498