The $36B Halliburton-Baker Hughes Merger and the Glut Shrinking the Oil Industry

Oil industry giant Halliburton's announcement Monday that it intends to buy competitor Baker Hughes, Inc., for $34.6 billion may signal the start of an oil industry contraction in the United States.

After a month of tumbling oil prices, Halliburton bid on the smaller Baker Hughes in order to combine the second and third-largest oil services companies.They are both behind global behemoth Schlumberger in terms of market cap size.

Both companies are oil services providers: they build equipment used in drilling such as specialized shale drill bits, pipelines, and underwater drills, and then help oil companies locate and create drilling sites, including finding new shale and finding new ways to extract oil from mature fields, according to information from the companies.

Halliburton Chief Executive Dave Lesar said on the conference call announcement Monday that the two companies would "create a bellwether oil field services companies" and said it was the right time for the "strategic" move.

The consolidation of two of the top players could be the beginning of a run of mergers, according to IHS energy industry analyst Lysle Brinker, who discussed the merger with VICE News.

"The overall energy industry is maybe just getting unleashed with this first deal here," Brinker said.

Brinker explained that the industry has been plagued with rapidly rising costs over the past 10 years as companies have struggled to find new oil and gas reserves to tap. While prices held steady at about $100 per barrel for the past three or four years, they plummeted this fall due to a global supply glut, mainly due to the increase in US oil production and continued production from Organization of the Petroleum Exporting Countries (OPEC) nations. Companies have suddenly found themselves with high costs of production and lower profits, he said.

"It's not clear where the bottom is, or how long it'll be in that position, but it puts more pressure on companies," he said.

Tim Coburn, director of the Masters of Energy Business Program at the University of Tulsa and a former oil industry executive, disagreed, saying the Halliburton deal is more a "marriage of expedience."

"There are too many providers in the field right now," he said. "We have a lot of activity going on and quite a few different kinds of service companies, albeit that have some of the same specialized niches, and this is the typical kind of contraction like we would see in a drug company or airplane company," he said.

"I don't think we're in a sky is falling situation here," Coburn said.

Brinker noted that historically, lower oil prices have meant a consolidation in the industry, and so if the current low prices hang around for two to three years, "it will trigger a fairly large consolidation in the industry," including both oil producers and services.

The future of oil prices depends largely on OPEC and how it will deal with the glut, he said. OPEC will meet November 27 and could decide to lower production to combat falling prices; if they don't, prices will likely remain low, according to an analysis in the Wall Street Journal, which noted that Saudi Arabia had made it clear it would not lower production.

"Certainly there are companies in OPEC that have voiced concern to the media about losing market share that has largely been lost to the shale oil boom in the US," Brinker said, noting that oil production has grown by 3 million barrels a day over the last several years. "That's going to continue to threaten the market share of Saudi Arabia, Kuwait, and other financially sound OPEC countries."

"The general supply and demand shows ample supply of oil and growing supply of non-OPEC oil in the US, Brazil, and Canada, and that's in the context of slackening oil demand because of meager economic growth around the world," he said.

Coburn disagreed, saying he thought oil prices would rebound due to long-term demand from Asia.

"Have you counted the people in China lately? There's too much demand. It may not be today's demand, but in terms of energy and power it can't possibly stay down in a global economic perspective for a long time," Coburn said. "It may be driven by politics for awhile, which can actually help the consumer locally, but it's clearly a cyclical situation."

Coburn said that $100 a barrel was likely too high to sustain, but the price would even out likely somewhere between $75 and $100. "There's an equilibrium where companies are making money," he said.

Halliburton's and Baker Hughes' competitors, including Weatherford, Superior Energy, and National Oilwell Varco, did not respond to requests for comment on the merger to VICE News. Brinker said it was likely that some competitors would pressure regulators to take a hard look at the merger and anti-trust regulations.

Halliburton, in its announcement of the deal, said it would be willing to offload $7.5 billion of assets to ensure the deal passes anti-trust regulations.

Energy industry analysts from RBC Capital Markets and Raymond James both speculated in reports shared with VICE News that Halliburton may have to offload some businesses to see the deal go through. RBC Capital Markets said in its report the deal would receive "significant scrutiny from regulators"and that Halliburton will likely need to divest parts of its drill bit business, logging-while-drilling imaging business, cementing business, and drilling fluids business to comply with regulations. The company's competitors, including Weatherford and others, could be potential buyers of those businesses.

Halliburton's hefty offer of $3.5 billion to Baker-Hughes if the deal doesn't pass regulators is a sign of its confidence that it will, Raymond James analysts said.

"We get the message that Halliburton's management and counsel is quite confident that this transaction will make it across the finish line," the report from analysts J. Marshall Adkins, Praveen Narra, and James M. Rollyson read.The analysts were not available for interviews today.

If oil prices stay low, many small and midsize companies, in both drilling and services, could be prime targets for acquisitions and mergers, Brinker said. Many companies that had been focusing mostly on natural gas turned to oil when demand for gas fell, and had to spend more money to get into the prime oil drilling locations.

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Follow Colleen Curry on Twitter: @CurryColleen

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