The large increase in M&A activity is garnering the most attention in the energy space. This increase in M&A has investors wondering what companies are merging, acquiring new assets, and what this M&A activity really means?

The most recent merger that has taken place is between Royal Dutch Shell (NYSE: RDS.A) and the BG Group (LON: BG). This merger is estimated to increase Royal Dutch Shell’s deep water position, exploration, and liquefaction in the liquefied natural gas (LNG) market. It is also supposed to increase Shell’s oil and gas reserves by 25%, and greatly increase its presence in the liquefied natural gas market. This activity has shown that Royal Dutch Shell believes natural gas has a bright future.

The Canadian Oil Patch

Recently, ConocoPhillips (NYSE:COP) has been taking a large stake in the Canadian oil sands and US shale sector. Most investors haven’t taken notice because, in its most recent conference call, ConocoPhillips announced that it was going to decrease its capital spending (CAPEX) by thirty percent. But what went largely unnoticed, was the fact that ConocoPhillips pledged to increase its capital spending on Canadian oil sands and shale oil projects by 50%, despite the recent decline in oil prices. Related: What Happens To US Shale When The Easy Money Runs Out?

ConocoPhillips isn’t the only major oil company looking to invest in the Canadian Oil sector. In February, Repsol (Spain’s largest oil company), purchased Talisman Energy. Talisman is Canada’s 5th largest independent oil producer. This acquisition is estimated to increase Repsol’s oil production by 76 percent, and increase its overall reserves by 55 percent.

China’s State owned enterprises are also looking to come back into the Canadian oil sector. Recently, senior executives from Sinopec have claimed that they are looking to make some acquisitions in the Canadian oil patch.

This isn’t the first time China has purchased Canadian oil assets. In 2012, CNOOC (Chinese National Offshore Oil Corporation) purchased Nexen Energy, whose assets were primarily located in Western Canada.

Unlike in 2012, a large asset purchase by China now seems unlikely. The main reason is due to the large political backlash that was received from energy ministers in Alberta, British Columbia, and Canada’s own natural resource minister. They expressed concerns that Canada’s own natural resources might become property of foreign governments. A year after this purchase, Canada’s Prime Minister stated that they did not spend years of reducing government ownership of their oil assets, only to see them be purchased by foreign governments. And that Canada is open for business, but it isn’t for sale.

This is why China is now only purchasing small assets in Canada. Such as the one that took place in June of 2014, where China Oil and Gas group purchased Baccalieu Energy Incorporated.

It isn’t just the producing companies that have been looking to make oil investments in Canada. Billionaire investor Wilbur Ross is also looking to invest in the Canadian oil sands sector. Currently, he is looking to invest in mid and small cap companies, due to their larger stock declines. Related: A Closer Look At The World’s 5 Biggest Oil Companies

Reserves

China and its state owned enterprises aren’t just interested in buying oil fields. They are also attempting to fill up their strategic petroleum reserves (SPR), while prices are low. It is estimated that China has already purchased 19 physical oil cargoes for delivery in the month of April. That is equal to 9.5 million barrels of oil. It is believed that if China keeps buying at this pace for the rest of the month, it will surpass its October 2014 orders, which equated to 23.5 million barrels.

It isn’t just China that’s filling up its SPR. The Department of Energy has also made a proposal to purchase $5 million dollars of oil for its SPR.

What does all this Mean?

When investing in the resource sector, an increase in M&A can mean a lot of different things. Currently, some analysts believe that an increase in M&A means we are near or at a bottom in this downward cycle.

When looking at these two charts above, it does show some correlation between the price of oil and M&A activity, but that doesn’t seem to always be the case. From 2004-07, M&A greatly increased as the price of oil increased. This was probably due to new wells now becoming economic due to higher prices. In 2009, shortly after the 2008 crash, M&A increased again as assets became cheaper. Related: Wall Street Bets On Oil Price Rally

When it comes to M&A, not all activity is motivated by a means of profiting from a rebound in oil prices. The Baker Hughes and Halliburton merger was inspired out of fear that they would face hostile negotiations from oil producers to lower prices. If they were to lower their prices, Baker Hughes and Halliburton’s profit margins would be greatly reduced. But by merging, both companies would have more leverage in future price negotiations.

M&A is also done as a means of replacing reserves. By acquiring a smaller company, a large oil producer can replenish its balance sheet reserves, while avoiding the risk of exploration, and drilling a dry well. Oil companies also acquire smaller companies, as a means of adding new technology or patents from that firm as well.

To conclude, the recent wave of M&A in the oil and gas sector doesn’t just point to one thing. It points to two things: one, that companies and governments are looking to replenish or add to their reserves; two, that they are clearly betting on higher oil prices in the future. If oil producers thought higher prices weren’t going to occur in the foreseeable future, they wouldn’t be interested in buying up Canadian oil sands assets, which are one of the more capital intensive ways of producing oil.

By John Manfreda of Oilprice.com

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