Repsol down - European mid-caps out

The nationalisation of Spanish oil producer Repsol's Argentinian assets cannot be seen in isolation. It points to a much wider problem for mid-sized European energy producers: they are being squeezed out of the market on one side by independent wild-catters and on the other by increasingly powerful emerging market governments that prefer to deal with Big Oil companies. To get out of this bind, the Repsols of this world may have to band together - or seek Asian assistance. What they cannot afford to do is stand still, argues energy analyst Matthew Hulbert.

Graffiti in Buenos Aires: "Repsol, get out of YPF" (Reuters)

Repsol's blunt ejection from Argentina poses some major questions as to how mid-size European oil and gas producers will be able to navigate an international landscape that no longer seems to be designed for them. Putting aside the details of the squabble between YPF and Repsol, the bottom line is that Argentina is sitting on massive unconventional reserves and it clearly didn't think Repsol was going to be the partner to carry things forward.

The fact is we have entered a new global energy world. Colonial links are gone, emerging markets are sitting on massive unconventional resources, and they're all in a rush to unlock them. What's more, they know Big Oil is best placed to do it, providing vast wads of cash and technology to get things rolling. Big Oil in this case means (western) international oil companies (IOCs) like Exxon, Shell, BP,Chevron and Total, but also Asian national oil companies (NOCs), like Sinopec and PetroChina, which are rapidly learning the ropes and becoming an increasingly attractive Plan B for emerging markets if these don't like what they can get from the IOCs. In this new equation, mid-cap European players don't really figure anymore.

Taking on more risk

In the old days, you could argue that the smaller European companies could chase smaller plays with higher risk. But on this front, not only are the European players weighed down by heavy state influence, they have also been surpassed by far more agile, privately owned wildcatters, cornering this 'high risk-high reward' market. Think of the likes of Tullow, Ophir and Cairn Energy from the UK, and Apache, Anadarko and Jubilee spreading US credentials worldwide.

Mid-cap US outfits such as Chesapeake can at least fall back on US domestic shale plays, but their European counterparts don't have that luxury. Domestic European shale remains a long short to make commercially viable; even if the geology and economics eventually stack up, NIMBYISM is rife across Western Europe. If European mid-caps want to survive, they have no choice but to work out how they can back into an upstream world that has increasingly left them behind.

This split is already playing out. Smarter European mid-caps are taking on more risk to enhance international footprints rather than slowly waiting to die. British based BG Group is one clear example of this in Africa. Gdf-Suez has been trying hard to enter Asian markets with €55 billion expansion plans. Centrica has been out and about in Qatar. Wintershall has being foraging in Russia, Latin America and Africa and Italy's ENI has realised it can't just rely on North Africa if it's to prosper, branching out into East Africa and potentially Russia.

While such moves are advisable, the key question is whether the mid-size companies can sustain the required investment and navigate the large risk to make things stick. Still, looking towards far flung markets seems a better bet than investing considerable time and corporate effort on small amounts of gas coming out of Azerbaijan, as some German, Austrian and Hungarian companies are doing. This is perhaps marginally better than sitting on depleting rents in the North Sea, but not much.

Mergers and acquisitions

Consolidation is of course the other way to go. Repsol's fall might well trigger a wave of European mergers and acquisitions to protect market positions. For Repsol, that might mean opening talks with Gas Natural in Spain, or exploring options with Portugal's Galp, if not going cap in hand to France to

Repsol's fall might well trigger a wave of European mergers and acquisitions to protect market positions
forge a 'Mediterranean Union'. German beasts such as EON and RWE have already dropped hints about a merger - a move that shouldn't be underestimated given both entities are having to divest core assets to mop up Germany's nuclear mess. They might join with OMV (Austria) and MOL (Hungary) to create a Central European behemoth. Either that, or they will have to look to the likes of Gazprom for deeper vertical integration cover from the East, or to Algeria in the south or Norway's Statoil to the North.

The final option would be to look towards Asian NOCs to provide fresh political capital and clout in the world. No doubt many European players will sniff at that prospect. They shouldn't. It was only two years ago that Macondo nearly took BP under; the suitor of choice would almost certainly have been PetroChina for the City of London. BP is still recovering, but the likes of Repsol and other European mid-caps will find life very hard in a post-Argentina age. If China happens to show interest, European minnows should think themselves very lucky. To stand still, in the new Age of Unconventional Big Oil, is a formula for premature death.