Is a Turnaround in the Works for Oil & Gas M&A?
A large segment of the oil and gas industry adopted a wait and see approach to engaging in M&A following the drop in oil prices that began in November, 2014.
14 March 2016
A large segment of the oil and gas industry adopted a wait and see approach to engaging in M&A following the drop in oil prices that began in November, 2014. Current stress on this sector has led producers worldwide to reduce drilling, downsize production, and cut or eliminate dividend payments. “West Texas Intermediate crude has slumped 70 percent since its mid-2014 peak and hit a 13-year low of $26.21 a barrel earlier in February,” says Bloomberg Business. As a result, M&A in the industry have hit the lowest level seen in a decade, as buyers and sellers are waiting to see when, and how, prices would stabilize.
A report from Deloitte found that in 2015, M&A deal volume in the three major sectors in the Oil & Gas industry (upstream, midstream and downstream) were below their volumes during the Great Recession. There were 379 M&A deals in 2015, down from 709 the year before, and from the 409 and 389 that took place in 2008 and 2009. Total deal value for the sector was also down to $286.23 billion in 2015 from $353.97 billion in 2014, which is a 24% decline year-over year, despite several mega-deals. Royal Dutch Shell’s $82 billion acquisition of BG Group alone made up 77.6% of the top 10 upstream deals during the year. Even with the inclusion of that transaction, the overall value of M&A transactions for 2015 was also down 20% year-over-year, according to Deloitte. Given the sector’s doldrums, one would, at a minimum, expect value-oriented players to start nibbling. Private equity firms have raised more than $20 billion for energy deals in the past two years, though the money has largely remained on the sidelines, in part because of valuations gaps. One can argue that consolidation must occur in order to stabilize capital structures and leverage scale, and that companies with stronger financial positions should be actively tapping the market as lower oil prices are baked into valuations.
But how much longer can distressed producers hold out? With Brent crude languishing at about $30-35 per barrel, a shake-out is looming, particularly among heavily indebted US shale producers. Around one-third of listed producers worldwide are at high risk of bankruptcy according to a study by Deloitte, as their collective debt has surged to about $150 billion while cash flows, and reserves, have dwindled. Weak oil prices encouraged industry consolidation in the mega-merger wave at the end of the 1990s, and conditions today might seem similarly conducive.
Deal flow however has been slow to ramp up. When the price of oil changes as rapidly as it does under current conditions, and expectations about the future direction vary widely, it becomes more volatile in bridging valuation gaps. Sellers are reluctant to dispose of assets because of the low prices and companies with relatively stronger balance sheets may try to wait-out a possible rebound or correction. Furthermore, companies in financial distress are unlikely to be attractive takeover targets. If a potential target has debt trading at far lower than dollar value or is leveraged beyond recompense, acquirers may choose to wait for a potential bankruptcy petition and purchase assets without assuming lingering creditor related issues.
Given time, most distressed assets in the sector will face untenable headwinds that will force many of them to exit under less than desirable terms. As distressed companies are running out of time, and resources, to raise cash for debt repayments and with limited to or no access to the equity and credit markets, companies have no other options but to consolidate. About 150 oil and gas companies tracked by energy consultant IHS Inc. are on the verge of bankruptcy, twice as many as those that have already filed. A further shake out will help stimulate deals that have been on hold, because sellers will have to become more flexible on deal terms and valuations, something which they have been reluctant to do until now.