Welcome back to Energy Source.

BP has been in the spotlight since last week’s announcement it will slow its shift away from oil and gas. Executives have been sent out to defend the move: the head of its low-carbon business told my colleague Tom there was “absolutely no link” between the decision and lower renewable returns.

Climate groups may be furious over what they see as a cynical reneging on green commitments. But investors seem happy — shares are up 12 per cent over the past week. That has prompted questions over whether others might follow suit.

Shell is the other supermajor that has been particularly vocal on plans to pivot to a greener model. Is a similar backpeddle on the cards there? We’ll be watching closely as Wael Sawan, Shell’s new top dog, lays down his strategy for the supermajor over the coming weeks and months.

Elsewhere, Europe is fighting over nuclear power again. A new EU framework says hydrogen produced using nuclear-powered electricity can be labelled “green”. France is happy. Germany is not.

And check out Derek’s dive with Stephen Foley, our accounting editor, into the middlemen set to reap big rewards from the US Inflation Reduction Act.

In today’s newsletter I report on the surge in M&A coming for the US shale patch as operators look to snap up the dwindling number of high-quality locations that remain. (For the latest M&A oil news in energy and elsewhere, sign up to the FT’s Due Diligence newsletter.)

Amanda looks at the controversy surrounding a multibillion-dollar Ford battery plant in Michigan — and the difficulties it illustrates in building a domestic clean energy ecosystem without Chinese involvement.

Thanks for reading — Myles

An M&A wave is coming for the US shale patch

We are bracing for a deals boom among oil producers.

Buyers and sellers alike are mobilising teams as the market gears up for a flurry of buyouts and tie-ups. Bankers and lawyers reckon it’s going to be a busy year for shale patch M&A.

That is what they told Justin and I in recent days. You can read our story here.

These are our main takeaways.

1. ‘Alarm bells’ are ringing over dwindling reserves

The key driver of the expected deals boom is a simple one: producers are fretting over a lack of remaining inventory.

The decade of debt-fuelled drilling binges that made the US the world’s biggest oil producer has chipped away at reserves. Wellheads placed too tightly together in the rush to exploit hydrocarbons have weakened pressure in many of the country’s prime drilling locations. Yields are slipping.

What Wil VanLoh, Quantum Energy Partners boss, dubbed shale’s “dirty secret” in an FT interview two and a half years ago seems to have come to pass. “We’ve drilled the heart out of the watermelon,” he told us in October 2020.

The upshot of this is that operators have been forced to re-evaluate how much production runway they still have, setting up a scramble to snap up good acreage wherever they can — be that through tie-ups between public operators or buying out private players.

As one banker put it to me:

“What’s driving our M&A book — which is robust right now — is the desire of public companies that have on average eight years of remaining drilling, to increase that inventory [because] we’re going to be producing oil in this country for 50 years plus.”

Another banker was more blunt: “Alarm bells are ringing about the lack of resource available,” he said.

This is increasingly being reflected in company valuations. If an operator has less than 10 years worth of drilling sites in its portfolio, according to Andrew Dittmar at Enverus, its stock is getting discounted.

2. The market is keen

If companies have motive for an M&A blast, now they also have means.

For one thing, after a year of record profits and caution on capital expenditure, they are rolling in cash. Rystad estimates the shale patch took in more than $150bn in free cash flow last year, and will add another $120bn this year.

They’ve used this haul to pay down debt, strengthening balance sheets. Moody’s says credit rating upgrades outnumbered downgrades by a factor of seven last year for US oil and gas producers.

And capital markets are less oil-averse than they were 18 months ago, investors say — making equity raises simpler. (Shareholders are keen that companies don’t regress on the debt front, so leveraging up is less of an option.)

On the seller side, meanwhile, many private equity groups are anxious to exit investments at decent prices as they embark on new funding rounds.

“That leads to both dispositions and acquisitions picking up,” said Preston Bernhisel, an M&A partner at law firm Baker Botts. “I think it will be a substantial, noticeable increase — even if it’s not an immediate frenzied pace.”

Smaller publicly listed oil and gas producers are also prime targets as they struggle to access debt and equity markets.

The bid-ask spread — or what buyers are willing to pay for assets versus what sellers want for them — was the major challenge last year in the market. Now that this has now narrowed considerably, according to bankers, deals seem imminent.

“My prediction is it’s going to come,” said Buddy Clark, a lawyer at Haynes and Boone. “When it does, everybody’s going to jump on the bandwagon. It’s not gonna be a slow drip.”

3. Gas is sitting this one out (for now)

Most of the M&A activity will be confined to oil for the time being.

Natural gas operators may yet join the party, but this will take some time, for a number of reasons.

One such reason is pricing. While crude prices have stabilised around the $80 a barrel mark, providing decent valuations for sellers, natural gas prices are still volatile. At around $2.50 per million BTU, they are sitting at a quarter of the high watermark last year.

And with expectations rife across the industry that new liquefied natural gas export capacity starting up next year is going to buoy prices, nobody wants to sell at the trough of the market if they can avoid it.

Another reason is antitrust. After the last wave of consolidation cut the number of significant producers in the north-east from 20-plus to three, regulators are wary of more tie-ups.

That has put the brakes on a planned $5.2bn buyout by EQT, the country’s biggest natural gas producer, of THQ Appalachia as the Federal Trade Commission reviews the deal. Other would-be buyers in the region are waiting to see what happens in that case before making any moves of their own. (Myles McCormick)

Data Drill

Even as the US pours billions of dollars into clean energy through the Inflation Reduction Act, wresting control of the market away from Chinese dominance is proving tricky.

Carmaker Ford yesterday announced plans to build a $3.5bn battery factory in Marshall, Michigan. But the project has been mired in controversy over its reliance on services from China’s CATL, the world’s largest battery manufacturer. The state of Virginia previously rejected the plant, which its governor Glenn Youngkin described as a “front for a company that’s controlled by the Chinese Communist party”.

The case underscores the difficulty the US faces in building a domestic clean energy supply chain from the ground up without relying on China — which is years ahead in the race to build EVs and batteries.

China accounts for two-thirds of the world’s battery production and more than half of the world’s electric vehicles, according to the International Energy Agency. The country’s investment in the battery sector is four times higher than the US, according to Benchmark Mineral Intelligence. (Amanda Chu)

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