Following the Shell/BG deal announcement yesterday morning, we've fielded some incoming questions from Oilpro readers asking what this transaction means for the rest of the oil and gas industry.

For starters, it is confirmation that M&A is heating up during this phase of the downcycle. In a presentation we gave last week, we conveyed the notion that M&A deals are about to become much more frequent across the O&G value chain.

Our channel checks suggest a burgeoning deal pipeline. While few transactions may come close to the size of Shell for BG ($70bn), we do expect smaller scale consolidation to add up to a meaningful trend this year and next.

Consolidation in E&P is not great for the service industry and vice versa. The reasoning is best explained by Porter's Five Forces. 2 of the 5 tenets of Porter's philosophy are i) bargaining power of suppliers and ii) bargaining power of customers.

When E&Ps consolidate, they have more leverage over their suppliers (i.e. the oil service and drilling contractors). When contractors merge, they are able to push prices higher for E&P operators and sometimes quality can be adversely impacted. A rising concentration of players in any one sub-segment of the industry generally hurts the other side.

And in the E&P industry in particular, scale achieved via consolidation can lead to overall capex reductions, reduced exploration activity, and deferrals of some projects that once were high priorities requiring service / drilling contractor support. For example, if two operators exploring offshore West Africa merged, they might reduce the size of their contracted deepwater rig portfolio - via combination they can deploy assets across the play more efficiently. And in larger portfolios, return profile variation can create shifts in the timing of investment decisions for specific projects. Takeout premiums are often rationalized by the development pipeline of the target, which can curtail the future exploration activity of the buyer.

Shell & BG Will Reduce Oil Service & Drilling Spend Post-Deal

So turning to the Shell/BG combination in particular, here are three points from the companies' management team that are relevant to the oil service and drilling industry outlook:

• 1. Capex Falling. The combined entity will moderate organic capital investment, and management is looking at deferrals, cancellations, and divestments. The company will also examine its supply chain and procurement processes on a combined basis looking for efficiencies (read less opportunities for contractors).
  • 2. Cutting The Fat. Priorities in 2015 and beyond include acheiving $2.5bn in synergies, accelerating the reset of the supply chain, and looking at new options for capital efficiency. While the elimination of redundant internal resources will play the leading role in achieving synergies, external savings via enhanced bargaining power will have a cameo appearance in the synergy drama.  
  
• 3. Less Exploration Activity. Following the deal, Shell will reduce exploration activity and exploration spending to focus on BG's development pipeline. This impacts the entire front end of the oil service/drilling spectrum from seismic arrays to core analytics to drilling rigs and stim crews.