The second half of 2005, especially during December, was one of the busiest periods in recent memory in the E&P merger and acquisition arena. The half began with Chevron and CNOOC competing for Unocal in a $19.5-billion contest and ended with ConocoPhillips announcing its $35.6-billion bid for Burlington Resources. Plus, there were more than $18 billion in additional transactions in the period. Both of the mega-deals, especially ConocoPhillips-Burlington, herald the importance of U.S. assets to the majors' future. The majors, which have viewed the U.S. as a "cash cow" to fund international activities, see that, in this commodity-price environment, it is also a bona-fide growth area for even the largest companies. Strong forces on both the supply and demand sides of the transaction business continue to positively influence deal flow. On the supply side, high commodity prices create the opportune time for many private companies to exit, and allow them and public firms to realize unprecedented value for nonproved reserves and resources. On the demand side, private money continues to pour into the E&P sector and public companies, bolstered by favorable valuations, must feed the beasts they have created and continue growing. There are some exciting, major asset rationalizations occurring in certain major basins of the U.S., driven by the potential ultimate value of large-scale resource accumulations. Areas with huge ultimate resource potential, such as the deepwater Gulf of Mexico and the Barnett Shale, are red hot. Companies of all shapes and sizes ponder how to gain access to large-scale reserves and resources in all basins of the Rockies, where gas production is expected to more than double by the end of this decade. But there have also been large transactions in every other major basin of the U.S. as differing perspectives allow a seller to exit an area with a potentially handsome profit while still allowing a buyer to be confident in its ability to add upside. The current deal flow is a continuation of an aggressive two-year run in the U.S. M&A business, fueled by a marked increase in expected future prices. While 2003 was relatively flat, there is a notably strong inflection point in January 2004 for both gas-then $5.50 per million Btu (MMBtu)-and oil, which was $30 per barrel. Since then, the gas strip has almost doubled, and the oil strip has more than doubled. This quick rise is the catalyst to high deal flow that continues today. Serial acquirers During this two-year run, a number of companies have made significant acquisitions. A review of the most active acquirers in the past two years, based on announced, large-scale transactions, produces a "Billion-Dollar Club" of 19 producers. Among these, 11 have attained this status through multiple transactions, continued to lubricate the deal flow and, along the way, set impressively aggressive new metrics. Most in the Billion-Dollar Club are public companies; the two that are not, Mariner Energy and Rosetta Resources, were scheduled to go public at press time. For the serial acquirers, a great deal of their purchases have been of private companies. The appetite of public companies creates demand to which private companies provide supply, creating even more liquidity in the E&P business. Simply put, the business plan of many privates is to aggregate small assets into critical mass-say $100- to $500 million-to feed public companies' appetites for reserves. From north of the border, the Canadians are beginning to play a key role in U.S. deal flow. At purchase prices of up to $25 per barrel of oil equivalent (BOE), the Canadian market is currently the most expensive place in the world to buy reserves. The royalty trusts have an even more voracious appetite for growth than U.S. public companies and have been operating in a bit of a closed system of a defined size in Canada. Therefore, they have begun shopping in the U.S. and in certain international arenas. Finally, the fevered pitch of deal activity has stretched resources-other than money-very thin. Buyers must now take into account the availability of people, rigs and other supplies when evaluating how aggressively they can really chew through existing portfolios and how aggressively they can value potential acquisitions. The current full utilization and looming shortages of these resources are beginning to affect deal flow and could soften the seller's market. Major mergers The largest transaction announced in the second half of 2005 was ConocoPhillips' cash and stock offer for Burlington Resources, whose reserves are some 66% U.S., 25% Canadian, and the balance, elsewhere. A major's bid for a U.S. independent was anticipated in the market following Chevron's offer for Unocal. Majors and mega-majors have truly had difficulty replacing reserves and growing production in the U.S. The Chevron-CNOOC saga for Unocal concluded resoundingly in the second half of the year. In June 2005, CNOOC bid $67 per Unocal share, seemingly trumping Chevron's April offer of 25% cash and 75% stock. Chevron countered with a 40% cash/60% stock offer that, combined with skillful lobbying and public relations, swung the momentum back in its favor. CNOOC, which had started late but strong, finished weak; Unocal shareholders voted for the Chevron offer in August. Also during the second half, Occidental Petroleum bid approximately $3.5 billion for Vintage Petroleum, consisting 40% of cash. Vintage's reserves were approximately one-half in Argentina, one-third in the U.S. and one-fifth in Bolivia, all of keen interest to Occidental. Vintage's shareholders accepted the offer in this past January. Also in the second half, Chesapeake Energy Corp., a well-established serial acquirer that has made more than $6 billion in purchases in the past two years, completed its acquisition of Columbia Natural Resources from Triana Energy Holdings in a deal valued at more than $3.1 billion in cash and assumption of liabilities. This was Chesapeake's first foray into the Appalachian Basin and answered the question "what will Aubrey (McClendon) do next?" Gulf of Mexico During 2005, resource plays of all types became the hot item and the deepwater Gulf of Mexico led the way. Activity there burst onto the scene in May 2005 with Statoil's $2-billion bid for EnCana Corp.'s properties in the region, and accelerated during the second half. Spinnaker Exploration took note of the market conditions and metrics in the EnCana-Statoil deal, and decided to test the market, resulting in the company's $2.56-billion cash sale to another Norway-based producer, Norsk Hydro. This further bolstered the notion that large-scale resources (not only reserves) could be sold for cash. For Norsk Hydro, the acquisition was a strategic move to greatly strengthen its Gulf position-key to the transaction was the intention of both seller and buyer to retain the entire Spinnaker staff with the assets. Both parties recognized the value of the going concern, not just the physical assets. Applying simplified metrics based upon other announced deals, both the EnCana and Spinnaker portfolios yielded exploration value for the sellers of approximately $1 billion. It is only a recent development that resources command such value. There is also good reason to expect buyers of these assets to ultimately profit as well through some combination of price upside, new technology, additional reserves and other serendipity. This expectation is also reflected in onshore basins with current equity valuations of E&P companies such as Ultra Petroleum, Quicksilver Resources, Southwestern Energy and Warren Resources. Another deepwater deal involved Total E&P USA's trade with Shell Exploration & Production for Shell's 17% nonoperated interest in the Tahiti deepwater field. In exchange, Shell received Total's gas-producing assets in South Texas (107 million cubic feet per day). Tahiti is a world-class-size field with facilities currently being fabricated for 125,000 barrels of oil and 70 million cubic feet of gas per day. Production is expected to begin in mid-2008. In the continuing trend of international companies entering the Gulf or adding significantly to Gulf portfolios, Australia-based Woodside Petroleum Ltd. acquired Gryphon Exploration in a $297-million transaction. Woodside has clearly stated this is just the first step in its intention to build a significant Gulf position. Joint ventures An interesting trend related to resource plays is the emergence of large-scale acreage and drilling joint ventures. The larger companies, with huge acreage positions they cannot possibly chew, are teaming with smaller companies in drilling deals. This structure bridges the gap between an outright divestment and immediate drilling, which the companies may not have the time and resources to conduct. The smaller companies that enter these agreements generally receive favorable treatment in the equity markets for the exposure to these large-scale resources. Examples of this are the crossborder deals in the U.S. and Canada between ExxonMobil and Apache, and a South Texas deal between ExxonMobil and Newfield. In recent months, the majors have turned this structure around and have actually begun taking positions from smaller operators in major resource plays. These types of deals are not widely disclosed by the companies, but various news sources have reported deals, such as Shell taking a 75,000-acre Barnett Shale position and, separately, also taking a 70,000-acre Fayetteville Shale position. ExxonMobil is also reported to be entering the Barnett Shale through a similar joint-venture-type transaction with an undisclosed company. These transactions allow the super-majors to stick their toe in the water, to learn how they can effectively explore and develop these large resource plays, and to study other possible opportunities to greatly expand their presence. This will be a continually emerging trend in 2006. One of the larger acreage deals during the year was The Exploration Co.'s (TXCO) sale of interests in approximately 300,000 acres in its Maverick Basin play in South Texas to EnCana Oil & Gas (USA) for $80 million. TXCO retains interests in two geologic intervals and, after a two-year drilling program, the companies will adjust and partition the acreage with each retaining 100% in their respective acreage. Sellers Privately held Celero Energy sold its assets in West Texas and Oklahoma to Whiting Petroleum Corp., another Billion-Dollar Club member, for a total of $802 million in two transactions. The deal broke through the $100,000-per-flowing-BOE barrier in a year when many new deal metric standards were set. El Paso also reemerged squarely back in the game with its $834-million acquisition of Denver-based Medicine Bow Energy Corp. One-half of the Medicine Bow properties are in the Rockies, and the balance is roughly split between the Midcontinent and East Texas/Gulf Coast, offering El Paso diversification and growth in multiple areas of interest. Going public. Some private companies found opportune ways in which to go public. TXOK Acquisition Inc., affiliated with Dallas-based Exco Resources, acquired all the E&P assets of Oklahoma-based utility Oneok for $645 million in September 2005. Shortly after the announcement, Exco reported its plans to once again go public through an IPO. The shares began trading in February. In another deal, Forest Oil announced plans to spin off its Gulf of Mexico operations to shareholders via a merger of the assets' holding company with privately held Mariner Energy Inc., which plans a simultaneous IPO. The Forest assets are valued in the deal at approximately $1.25 billion. Canadian buyers The slowly developing southward expansion of the Canadian royalty trusts into the U.S. picked up a bit of steam with Enerplus Resources' acquisition of Lyco Energy for approximately $384 million plus the assumption of debt. Lyco's assets are in Montana and North Dakota and include the Sleeping Giant light-oil project. In a follow-up deal, Enerplus acquired Sleeping Giant LLC, which held additional interests in the Lyco asset area, for $91.6 million. Continuing this trend, Enterra Energy Trust announced an acquisition of Oklahoma properties from an undisclosed group of private sellers for $246 million. This is a significant deal as it is a move by a trust deep into the heart of the U.S. onshore oil and gas business somewhere other than the Rockies. Good buys Into 2006, the torrid pace of transaction activity was continuing. Chesapeake announced acquisitions with seven private companies in the Barnett Shale, Permian Basin, South Texas, Midcontinent and East Texas totaling $796 million. Cal Dive International signed an agreement to acquire Remington Oil and Gas in a cash and stock transaction valued at $1.4 billion. The latter deal has transaction metrics for proved reserves of $5 per thousand cubic feet equivalent and exposure to more than 1 trillion equivalent in additional reserves and resources. And, Petrohawk Energy is continuing its torrid growth, announcing acquisitions in North Louisiana for $262 million. This follows Petrohawk's acquisition of Mission Resources in July 2005. Deals announced in January 2006, including Kerr-McGee's sale of its Gulf package to W&T Offshore, totaled more than $4 billion alone. Other large-scale divestments under way in 2006 include Houston Exploration's planned Gulf exit, Pioneer Natural Resources' deepwater Gulf exit, Chief Oil & Gas' planned Barnett Shale sale, and the exit of privately held Latigo Petroleum, which has assets in the Anadarko and Permian basins. Based upon public announcements, these deals alone are expected to total at least $4- to $5 billion, forming the foundation of an active early 2006 market. There will no doubt be announcements of other large-scale transactions. A number of private companies are entering the divestment market, the equity markets continue to apply negative pressure to Gulf of Mexico portfolios, and the Barnett Shale and other resource plays remain hot. Finally, every large company, up to the mega-majors, is searching for deals to re-establish presence and reclaim positive momentum in the U.S., which still offers the most attractive cash margins in the world in this high commodity-price environment. The wobbling two-year strip may create some consternation, but the spoils will go to the companies that establish the correct early view of where the market will be in the near future and to those that are creative in balancing aggressiveness with risk management. It should continue to be quite an interesting 2006. William A. (Bill) Marko is managing director for Houston-based energy M&A advisory firm Randall & Dewey, a division of Jefferies & Co.