Say it ain’t so, Subash. New York-based sell-side analyst Subash Chandra, Jefferies & Co. Inc., coming off a meeting with ConocoPhillips chief Jim Mulva in early October, penned a research piece concluding that shale plays are sucking the capital out of acquisitions. Not just because shales cost a lot to develop, but also because their low-risk, repeatable nature and enormous size make them a better avenue to production growth than, say, the old (old?) acquire-and-exploit model.

Mulva told the analysts that ConocoPhillips, following its downstream spinoff, would concentrate on greenfield exploration rather than growth though acquisitions. Where’s the adventure in that?

The disconnect arises because the dramatic success in the shales is causing what was once a clear link between commodity prices and E&P spending to break down, Chandra postulates in his early October 4 report, “Being Independent—Why Drilling Capex May Not Go Down.”

“The superior risk/reward ratio in unconventional drilling is causing companies to devote more of their resources to developing assets organically vs. through acquisitions.”

Woe is me, an A&D junkie by trade.

Chandra’s report pushes the argument that drilling capex (and rig counts) will be sustained or even increase in the face of soft commodity prices, in spite of historical trends. For 10 years previous, aggregate capex vs. both cash flows and commodity prices have trended in lockstep, by a factor of 97% and 99%, respectively.

But shales have created a vigorous appetite for exploratory drilling. In 2010, for the first time in a decade, capex exceeded each measurement. First-half 2011 blew historical stats out of the water, with capex hitting 122% of cash flows.

“We believe this is a direct result of the shale revolution,” says Chandra. “Our premise is they (E&Ps) will drill through everything but a credit crisis.”

This heady drill spend is at the expense of deal-making, he says. Historically, companies acquired their way to growth when commodity prices declined, as long as equity and credit markets were open. “Companies could reload inventories by buying assets or companies that had derisked a play.”

As independents have pushed harder into shales, however, they are now relying less on acquisitions and more on the drillbit to grow volumes. Over the past two and a half years, Chandra notes, acquisitions have dropped to 20% of total E&P spending, down from an average of 30% over the past decade—and they are continuing to fall.

Exacerbating the reversal: the cost of entry in new shale plays increases rapidly as they are derisked. Being a second mover is prohibitive for an independent E&P.

“As a result, traditional acquire-and-exploit models are working hard to improve their exploration expertise.”

Take Devon Energy, for example, once an active acquirer. The company has set up a new ventures team to search for new plays.

“Their intent is to get away from acquisitions as a whole. Acquisitions are expensive—the costs of being late to a play are punitive. You’re much better off being an early mover.”

Devon is not alone. Shale-driven independents are en masse trading acquisition dollars for R&D divisions. Leasing expenses, too, are absorbing a bulk of bucks. “If you already have shale, you’re drilling away. If you need more shale, you go leasing.”

Alas, the certainty of a shale-well return on investment trumps having a pocketful of brand-new assets in the portfolio. Shale opportunities last longer, and have a better probability distribution and better repeatability than do conventional plays.

Money is no obstacle to acquisitions—equity and debt markets are easy now. “Capital has not been a limiting factor for smaller operators (except during the financial crisis), as long as their resources are economic at the prevailing commodity prices.”

And yet independents would still rather not acquire assets. “They would rather use the equity to drill. They have a lot of potential wells. That’s the whole difference now vs. the first half of the last decade. Then, those opportunities did not exist, so they had to reload and acquire.”

But… not everyone has shale—yet. While independent E&Ps loaded with shale opportunities are no longer aggressive acquirers of asset packages nor of each other, they have instead become targets of larger entities devoid of shale. For a time, he believes, M&A of shale independents will increase.

valuations are reflecting long-term prices lower than the strip,” says Chandra, exactly opposite of the norm. “They are transactable. There is a huge pool of players out there that can buy independents.”