The drop in oil prices is now a continuing story. After roiling the equity market for over a year, the series of drops in multi-year low crude price is now forcing major energy players to think and rethink their production plan just to survive an unfavorable business scenario. Even defensive measures haven’t helped, as these merely mean compromising on operations. In fact, most of the energy companies have a huge debt burden that they can’t write off as cash flows from core operations aren’t enough.

In such a situation, many energy players are merging with their rivals for synergies in the hope of broadening their scope of operations even though business is not in their favor. As per Dealogic, 2015 has seen $323 billion in declared oil and gas company mergers so far. Most importantly, mergers between oil and gas companies have boosted the world-wide deal volume this year to $3.2 trillion, setting 2015 on the course of breaking the $4 trillion plus deals’ record in 2007.

Are the energy companies doing the right thing at right time? If yes, then how?

Factors Driving Mergers

A synergy takes place when the combined value of two companies is more than the sum of the individual value of the firms. Almost every time companies opt for a merger only when they see opportunities for synergy. Most importantly, the business environment is the main driver of mergers and acquisitions.

In this article, we will discuss the reasons behind the record energy company mergers that have taken place this year. Definitely, the primary driver is the plunge in oil prices. So let’s first analyze the reasons for this oil carnage.

During 1990 and early 2000, the U.S. was more dependent on crude import as domestic demand was far above its conventional oil supply. But with the invention of new techniques like hydraulic fracturing and horizontal drilling, U.S. shale producers relentlessly ramped up oil production. Eventually, owing to its huge scale of crude output, the U.S. started relying less on oil import.

The shale boom turned the U.S. into an oil surplus economy from a crude deficit market. Along with the U.S., the Organization of the Petroleum Exporting Countries (OPEC) also pumped up more crude. All these events led to a global oversupply of the commodity and pushed oil to its multi-year low marks. West Texas Intermediate (WTI) crude closed at $44.74 per barrel yesterday, less than half the price of the commodity during the mid-2014 level, when oil was trading above $100 per barrel.

With the persistent decline in oil prices, upstream energy firms are in rough waters as they can't sell crude at attractive prices. Moreover, the shale producers are laden with huge debt. In fact many such companies are paying dividends from borrowings and some have even stopped.

Offshore drilling contractor SeaDrill Limited (SDRL - Analyst Report) was one of the prime names that suspended dividend payments for an indefinite period in November 2014. Many analysts are apprehensive that the energy players might not be able to afford dividend payouts if oil prices continues this downward journey.

What Should These Energy Firms Do Now?

Perhaps a merger is the easiest way out of the woods for these beleaguered energy players. That’s because cost synergies and a bigger market presence can do the trick.   

Cost synergy will lead to the combined cost of the two companies to go down. This might happen if one of the merging firms has economies of scale, which implies that the higher will be the output, the lower will be the fixed cost per unit. The other catalyst – a bigger presence – generally means an increased market for the merged entity. Moreover, by merging both parties can share their management skills and exploration techniques to counter the crude price weakness with joint forces.

The imminent agreement of integrated energy major, Royal Dutch Shell plc (RDS-A - Analyst Report) to acquire BG Group plc, a leading upstream energy player in UK, for $70 billion is the biggest merger in the energy space in a decade.  

Another big merger in the low oil price era is the one that is planned between oilfield service behemoth Halliburton Co. (HAL - Analyst Report) and its smaller rival Baker Hughes Inc. The deal is valued as high as $35 billion.

Moreover, the world’s largest oil-field service company Schlumberger Ltd. (SLB - Analyst Report) announced this year that it has entered into an agreement to acquire Cameron International Corp (CAM - Analyst Report). Per the deal, Schlumberger will acquire its smaller rival in a stock and cash transaction valued at $14.8 billion.  

The overall weakness in the energy market following soft commodity prices also led Energy Transfer Equity (ETE - Snapshot Report) to take over Williams Companies (WMB - Analyst Report) at a much lower value. The agreement is valued at about $37.7 billion and includes the assumption of debt and other liabilities. The deal amount is much lower than the $48 billion offer from Energy Transfer Equity in June that Williams Companies had rejected.  

Most importantly, all the acquiring companies are expecting their respective deals to be earnings accretive.