The oil and gas sector has recently entered a phase of consolidation such as it has not seen in years. It was only a matter of time before the falling oil price would start claiming the operations of the smaller oil producers. For Talisman Energy Inc. (NYSE: TLM), its time has come.
“Talisman Energy Inc… has entered into a definitive agreement… with Repsol S.A. under which Repsol will acquire all of the outstanding common shares of Talisman for US $8.00 (CAD $9.33) per share in cash,” yesterday’s Talisman press release confirmed.
Integrated energy company Repsol of Spain will be purchasing Canadian oil and natural gas producer Talisman for $8.3 billion plus the assumption of $4.7 billion in debt. The deal is an opportunity for Talisman shareholders to cut their losses which have been piling up for years, and a consolation for Repsol shareholders who had a significant portion of assets taken away from them by the financially desperate Argentine government.
A look into the circumstances that lead up to Repsol’s purchase of Talisman sounds the alarm across the oil and gas sector, delivering a wake-up call that all is not well for wells. And it will get worse before it gets better.
Falling Oil Price Drills Deep Financial Holes
By now all are aware that the plunge in oil prices from $107.26 per barrel at the end of June to yesterday’s close at $55.37 for a loss of 48.38% in less than six months has taken a devastating toll on oil and gas stocks clear across the board. But in Talisman’s case, the decline in stock value began much earlier than that.
As a small cap energy producer, Talisman’s stock surged fantastically when oil was mounting a fantastic move of its own toward its all-time high above $124 a barrel back in July of 2008, lifting TLM from $4 a share in 2003 to $25 for a gain of 525% in five years.
But the economic crisis which took oil to as low as $32.40 by the end of 2008 served as a foreshadowing omen of events unfolding today, with Talisman’s stock plunging down to $7 a share over that same time for a drop of 72% in just 9 months.
Naturally, as the price of crude recovered back to above $114 in early 2011, Talisman was once again taken up its second roller coaster hill, back to $25 a share. But it was all downhill from there for Talisman’s stock entered a steady downward spiral to $10 a share even as oil remained flat between $90 and $100 a barrel for more than three years until mid-2014. These past six months were simply the final straw that broke the company’s back, cutting its share price to less than $4 a share by last week – back to the beginning of its once glorious run in early 2003. Talisman shareholders have been left with zero gains after more than a decade.
What’s important to note here is that Talisman had problems beyond just a falling oil price. From late 2011 to early 2014, even as oil held steady between $90-$100 just 15% below its 2008 all-time high, Talisman’s stock was holding steady at around $12 a share, some 52% below its 2008 all-time high.
In particular, “the North Sea properties owned by Talisman, in a joint venture with Sinopec of China, have been a particular drain on the company,” reports the New York Time’s Dealbook. “Production there has been dwindling while costs remain high. The company has said that it may write down the value of that operation in its fourth quarter.”
That is something of a double-whammy facing not just Talisman but other small cap oil and gas producers: not only are many of their wells being depleted, (or at least having the easier to reach resources dramatically reduced over the past few years of extensive over-drilling due to the high oil price, leaving only the harder-to-reach and more expensive to extract deposit remaining), but at the same time they are now receiving less money for the fewer barrels they are producing.
A look at Talisman’s income statements reveals that revenue has been falling for years, not just over the past six months, with total revenues plunging from $8.27 billion in 2011, to $7.17 billion in 2012, to $4.49 billion in 2013.
Naturally, the amount left over for shareholders after operating expenses has been shrinking as well, from +$776 million in 2011, to +$132 million in 2012, to -$1.175 billion in 2013. That’s right, over $1 billion in the negative applicable to shareholders in 2013 for a company that is worth only $8 billion. And remember, this was all before the recent plunge in oil prices.
Investors Tread With Caution
Investors thinking of snapping up some bargain-basement prices among the hardest hit oil and gas stocks have the right idea – generally. This is what drove Spain’s Repsol to look around the energy sector for some cheap properties to add to its collection.
With oil prices down some 50% this year, we can expect more of such take-over and acquisition activity, as the energy sector is ripe for consolidation. But it’s not only because of the falling oil price, as if a rise in oil is going to suddenly make everything better again.
The truth is that labor and equipment costs are up, and are increasing all the time. Plus, easy oil and gas reserves are down, and decreasing all the time. Companies are having to drill deeper under ground, and wade farther out to sea with each passing year. Small players like Talisman need a high oil price just to survive. But even then many such companies continually depreciate over the years as the easier oil and gas are depleted.
Investors aught to look at a company’s cash flows and the rest of its financials before picking up its stock. Are its costs increasing more than its revenues? Are its reserves depleting faster than new deposits are being found? How was its stock performing when oil was holding steady? If its stock has recently tumbled, was it simply because of the falling oil price, or is there some other more fundamental reason that won’t be easily resolved by a simple rebounding of the oil price?
Talisman’s rise and fall and upcoming buy-out by Repsol serve as a warning sign not just to oil producers but to investors as well. If we think the only problem with energy companies is a falling oil price, we need to think again.
There are political problems, such as Repsol encountered when Argentina confiscated its YPF subsidiary for just $5 billion in compensation – half of the $10 billion the company had filed for. There are employment issues and labor strikes in developing nations, such as the strike begun in Nigeria just this week. And of course, there are depleting easy deposits, leaving behind the more difficult and costly reserves to extract.
Given all these headwinds blowing across the energy sector, the larger players in the space with substantial cash flows are the only ones that will remain standing, while the smaller operations fall or are picked-off one by one through a wave of consolidation that has only just begun.
Oil prices will remain low for a while, perhaps another couple of years. This is not the time for small cap energy names. This day belongs to the behemoths.
Joseph Cafariello
