When Big Oil Buys Out the Big Diggers

The U.S. markets are closed today for Martin Luther King, Jr. But China has a dream too, and dreams do not take days off. The ASX/200 posted a record close yesterday, its 15th record close since October. The one-two combination of continued resource demand from China and continued private equity demand for stocks is behind the juggernaut.

What’s next? A new high? Why not? Or how about a twist?

So far merger and acquisition activity in the resource sector has been mostly an internal affair, with bigger fish buying smaller fish – BHP Billition’s bid for WMC and its uranium resources a few years ago, or the ambitious smaller fish chasing a lumbering bigger fish – Freeport McMoran (NYSE: FCX) chasing Phelps Dodge.

We have also suggested that private equity might get in the game too. True, earnings are cyclical in the resource industry and underlying commodity prices look increasing volatile. But there is a lot of money looking for a deal to do these days. It wouldn’t surprise us to see private equity start chasing resource assets too, in the much the same way that hedge funds stockpiled physical reserves of commodities like copper to benefit from its rise (before its fall.)

But here’s a thought for you, what’s to prevent big oil from buying big diggers?

We have in mind companies like ExxonMobil (NYSE: XOM) and BP (LON: BP.). Exxon has a lot of cash, about US$32 billion. It finds itself in the hunt for more oil reserves across the globe that are more expensive to find and more expensive to develop. And that doesn’t even include political risk. When oil companies aren’t getting kicked out of Russia or nationalized in Latin America, they’ve found themselves forced to do business in more and more dangerous places (Nigeria, for example.)

To save souls you have to go where the sinners are. And to find oil you have to go where the oil is-unless you decide to get in the mining business. Everyone views BHP and Rio Tinto (ASX: RIO) as acquirers of smaller resource companies. But Exxon, faced with rising geopolitical costs and diminishing returns on oil exploration, might be interested in a little business segment diversification at this point-not to mention a very wide back door into China. What is to prevent XOM from buying RIO. Or BP from becoming BPBHP?

BP has $3.2 billion in cash, which is $28.8 billion in cash less than XOM. And yesterday, the iconic peak oil skeptic Lord John Browne announced he’d be leaving the firm 17 months ahead of schedule. Lord Browne will be replaced by Tony Heyward, a man whom we know nothing.

Lord Browne often said ExxonMobil was the standard against which BP ought to judge itself. Judging by this chart, you begin to see why Lord Browne is leaving early. ExxonMobil began decisively outperforming BP in late July and early August of last year, about the time BP was forced to shut down production in Alaska’s Prudhoe Bay because of pipeline trouble and leaks. The stock rallied yesterday on the news of the management change. But where to from here?

Like all oil companies, BP must work harder and harder to find new reserves. The company has also raised its profile in alternative energy technologies. Yesterday it announced five North American wind-power projects to deliver a combined 550 megawatts of energy in California, Colorado and North Dakota. It will be interesting to see if its interest in alternative energy lasts. If oil prices remain at this level or go lower, how many alternative projects will be shelved? Will consumers care about going green if the black gold doesn’t put them into the red?

In the meantime, with little cash on hand compared to XOM, BP is seems like the ideal candidate for enlisting the help of debt or private equity to engineer an acquisition outside the energy sector. Of course, it could stick to the energy sector and chase a company like Woodside (ASX: WPL). There are quite a few options really. But we thought it was worth mentioning that cashed-up oil companies, faced with a shrinking pool of global energy assets and state competition, might just start diversifying into other resources.

All of this, of courses, would drive the indexes higher.

Dan Denning

Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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