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Energy industry seems ripe for merger wave

Another wave of mergers may be building in the energy industry as persistent high oil prices, stockpiles of cash and a shortage of inexpensive places to drill are driving companies to eye their competitors.

Two factors brought energy mergers to the forefront on Thursday: a report that ChevronTexaco may be testing the waters with Unocal Corp., and oil and gasoline flirting with record high prices yet again.

Industry sources confirmed a report in Thursday's Wall Street Journal that ChevronTexaco has taken a look at Unocal, but they note that so has just about every other energy company.

El Segundo, Calif.-based Unocal has been considered a likely takeover target for more than a year. In January, news reports said China National Offshore Oil Corp. was expressing interest.

As if to underscore the rumors, the price of oil shot as high as $55.20 a barrel on Thursday, near October's record $55.67, before tumbling back to close at $53.57, up 52 cents.

The move was fueled, in part, by a comment from the acting secretary-general of the Organization of Petroleum Exporting Countries in a Kuwaiti newspaper that he "can't rule out" the chances of $80-a-barrel oil in the next two years.

Many analysts view Thursday's results as an overreaction, and note that if inflation is taken into account, prices aren't as onerous. Citigroup Global Markets analyst Kyle Cooper said the current price environment "is not supported by traditional supply-and-demand economics."

Much cash, few reserves

Mergers are a regular part of the energy industry as companies are constantly buying and selling properties and projects in an effort to balance their portfolios. An average of 25 energy companies per year has been taken over in the past eight years, said Art Smith, CEO of research firm John S. Herold.

But while past merger waves were efforts to cut costs during times of low energy prices, it's the large cash reserves companies have built in recent years and the dwindling number of easy-to-reach oil and gas fields, known as reserves, that may trigger the next run of mergers.

"They can only buy back so much stock and pay down only so much debt with that cash," said Paul Meighan, head of Ernst & Young's Energy, Chemical and Utilities practice. "At some point they have to reinvest back into the business, and that means more hydrocarbon reserves."

One might expect high oil prices to discourage mergers, since buyers may be afraid they will pay too much for a company today if oil prices drop tomorrow.

But the demands by Wall Street that companies grow, or at the very least maintain, the size of their reserves from year to year has companies willing to pay higher prices to buy existing operations.

On Thursday, ChevronTexaco surprised many analysts when it reported its oil and natural gas reserves fell 6 percent last year, according to Bloomberg News.

Some of that was attributable to the sale of some North American fields, but it was also because of a review that showed smaller-than-expected deposits in Africa, Asia and the Gulf of Mexico. Shares of ChevronTexaco closed down 38 cents on Thursday at $61.19.

Given its current stock price, Unocal could be a relatively cheap way for a competitor to pick up reserves in key parts of Southeast Asia, Smith said.

It costs Unocal about $11 in exploration and development costs for each barrel of oil it produces, Smith said.

Merger risks

Unocal's reserves are equivalent to about 1.75 billion barrels of oil. Multiply that $11 by 1.75 billion, and divide by the number of Unocal shares outstanding — about 263 million — and you get a per-share price of about $74, Smith said. Unocal's stock closed at $60.10 on Thursday.

"That means its intrinsic value is much more than its stock price," Smith said, and is a relative bargain.

If the equation were that simple, however, Unocal would have been long gone by now. There are countless other risks that come along with any company's reserves that aren't easy to put a dollar figure on.

For example, Unocal's Yadana-Yetagun gas pipeline in Myanmar, which supplies gas to Thailand, has faced local opposition and has been watched by U.S. courts for alleged human rights violations. Other oil and gas fields are involved in other legal disputes. These problems are not unique to Unocal, but are factors that can delay or derail mergers.

Chronicle reporter David Ivanovich contributed to this report.

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