Upstream Oil and Gas M&A

A Window of Opportunity…and Risk

Many a Londoner will know the saying about having to wait a long time for a bus, and then three frustratingly arrive at the same time! Things are not so different in the oil and gas patch when it comes to M&A. After an unspectacular couple of years, it appears that we may finally be witnessing the beginnings of a wave of deal activity across the oil and gas sector. Deal values and volumes rose dramatically in the latter half of 2016, as companies announced a flurry of deals. With oil prices starting to stabilise, there is a sense in the market that we have turned a corner, unlocking deals that were unable to progress beforehand. In this rapidly evolving landscape we see a number of emerging themes: PE (Private Equity) pursuing deals in the North Sea; larger IOCs (International Oil Companies) conserving cash and looking to divest non-core assets; a greater willingness on both sides to explore deal structures to address buyer and seller needs; and a desire to explore alliances to exploit opportunities and capabilities more cost effectively. What companies do now in this environment may dictate their success in the future.

Watch our short video for an overview of what we see happening in the deals upstream oil and gas market

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The sector is on the cusp of a recovery

It has been a torrid time for the global upstream oil and gas sector in the past couple of years, with the impact of the downturn well documented. However, there is a growing sense the sector has turned a corner. Not least we may be witnessing a 'tentative' recovery in the oil price. The Brent oil price appears to be stabilising and trading in a range of between US$50/bbl and US$55/bbl. As supply and demand fundamentals begin to align more closely, partly accelerated by OPEC’s decision to cut production by 1.2m bbls/d, we have seen upward pressures on the oil price. That said, an oil price recovery will always be fragile especially if fundamentals shift direction.

Until the emergence of this “apparent” price floor, it has been challenging for buyers and sellers to agree a price for asset valuations. Now with the price in the low 50s and a sense there may be still some upside to Brent in the medium term, confidence in deal making is growing. As illustrated in Exhibit 1, global oil and gas M&A deal volumes for the second half of 2016 rose noticeably with ‘Pending’ deals (that is deals that have been announced but not yet completed) reaching nearly US$100bn by Q4 2016.

It is worth noting that deal volumes had already started to rise in Q3 2016 before the OPEC announcement at the end of November 2016 (whereupon oil prices were given a welcome fillip). This would suggest deal makers already anticipated a floor had been reached and early movers were sensing an opportunity to transact. So if we are on the growing crest of an M&A wave, what should buyers and sellers do so they don’t miss out on this window of opportunity?

Strategic and tactical responses to M&A

As some oil and gas companies sit on the sidelines watching the ebb and flow of M&A activity, they may be asking themselves, “How should we respond?” Should prices rise further, we would expect sellers’ price expectations to increase faster than the value buyers are willing to pay. And if prices decline unexpectedly, buyers could well become nervous about overpaying. So if you are in the game of deal making – what are your options?

Transformational M&A plays

Now may be the time to consider transformational M&A plays, such as the likes of Shell acquiring BG (to grow capabilities in the gas value chain). However, aside from the Shell example we have not seen any major upstream corporate deals. And given concerns around rising debt in a cost constrained world and the risk in executing these deals, we are unlikely to see a repeat of the mega mergers that redefined the sector in the late 1990s and early 2000s. Instead asset deals and bolt on acquisitions are likely to be the order of the day. Going forward, companies will likely favour asset acquisitions that build on existing opportunities and create focused portfolios (allowing optimal management of the asset and associated infrastructure). Smaller bolt on acquisitions that build a specific capability or expand the portfolio footprint in target geographies may also be another trend. Enquest’s purchase of a stake in the Magnus field, BP’s stake in Zohr and Exxon’s decision to grow its portfolio in the Permian all illustrate this point.

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Strategic alliances

We also see an increasing prevalence of strategic alliances as a more cost effective means of achieving mutual benefits. This is already happening in the oilfield services (OFS) sector, where alliances more often than not become a precursor to a merger (the Forsys Subsea joint venture between Technip and FMC being a case in point). More recently, Aker Solutions, DNO and Subsea 7 formed a development alliance in the Norwegian North Sea to provide integrated support to operators. We can envisage these type of partnerships occurring more frequently in the upstream sector outside of OFS. BP recently announced its partnership with Kosmos Energy to develop opportunities in West Africa, marrying the Independent’s exploration skills with the Super Major’s expertise in the gas value chain.

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Divestments of non-core assets

Another potential route is for companies to review their portfolios for coherence and consider divestments of non-core assets (which could generate additional cash for the business). Several of the IOCs have announced sizeable divestment programmes which are underway, including Shell (US$30bn) and ConocoPhillips (US$8bn). In addition, for some of the large IOCs, such as the super majors for example, these divestments reflect a rebalancing of portfolios as companies shift their focus to low carbon plays.

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The role of National Oil Companies

Perhaps most interestingly there is limited public insight into how many of the National Oil Companies (NOCs) will seek to participate in this wave of M&A. We have seen some initial transactions (such as Kuwait Foreign Petroleum Exploration Company - KUFPEC - acquiring assets from Total in offshore Norway and Shell in Thailand) but not enough deals to indicate how active they will be. To date we have not witnessed the degree of activity once demonstrated by the Asian NOCs (in particular Chinese and Indian) a few years ago. Given many of the countries supporting the NOCs have had their own economies adversely impacted by the oil price downturn, it will be interesting to see how the NOCs respond. The decline in fiscal revenues for Saudi Arabia for example, encouraged the government to pursue an IPO of part of Saudi Aramco and to diversify the kingdom’s economy from over dependence on oil revenues. While the flotation is very much a downstream focus, there is a broader question as to whether IPO vehicles becomes a template for some other NOCs, only time will tell. Moreover, will other NOCs seek to divest non-core assets to raise cash or will they make strategic asset acquisitions? Again one to watch closely.

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2017 - Private Equity in the ascendancy

As oil and gas companies ponder their options, we see PE becoming an increasingly critical catalyst in deal making. With an estimated US$80bn at their disposal, PE is well placed to play in the deal market going forward, although opportunities may not be sufficient to allow these funds to be fully deployed in the sector.

The UK North Sea is a good example of how PE can transform opportunities. Until recently, low oil prices suggested there was little room for optimism in this higher cost and mature basin. Moreover, the thorny issue of decommissioning liabilities added complexity to the Majors’ desire to divest assets to smaller players. This changed in the second half of 2016 as Siccar Point Energy (funded by Blue Water Energy and Blackstone) acquired OMV’s assets for close to US$1bn and Chrysaor’s announced deal to acquire assets from Shell for US$3.8bn. Further transactions are likely in the basin.

Both these deals highlight why the North Sea basin remains an attractive investment opportunity: it boasts a relatively stable fiscal regime; there is the opportunity to acquire large volumes of quality (albeit mature) assets with clear ownership; and there are quality management teams that come with these deals. Collectively, these deals allow PE and operators to use the North Sea as a growth platform for other ventures. Note for example, the Israeli oil and gas company, Delek, which made a takeover offer for Ithaca Energy in an effort to grow its international portfolio.

If we accept these characteristics of the North Sea as ingredients for success, where else might PE consider as potential regions for growth? Onshore US would probably resonate but the list of other target geographies would not be long[1].

"Higher oil prices have triggered an explosion in US upstream M&A activity after two years of near-paralysis…The Permian is leading the resurgence…In fact, the Permian has reported M&A activity of over US$11.5 billion in just the first four weeks of 2017!”

Brian Lidsky, Managing Director, PLS, Inc.

Mexico might be another focal point for investment, as the energy sector opens up. Riverstone already announced plans to invest US$1bn to finance infrastructure and E&P opportunities as the sector reforms. Moreover, PE may target other parts of the value chain such as oilfield services, where some players (onshore drillers) are seeing the early signs of a recover.

One further point around these deals (and more broadly across the oil patch) is the mechanisms being used to sweeten transactions. In the case of Chrysaor, decommissioning could have been a stumbling block. However, Shell agreed to retain a fixed liability of US$1bn for future decommissioning with Chrysaor covering an estimated US$3.9bn of the decommissioning bill. Equally the deal included contingent measures around future payments between buyers and sellers depending on where the oil price goes (higher oil prices would require Chrysaor to pay additional amounts to Shell, lower oil prices would be the inverse). Given the uncertainty around oil prices, we are likely to see greater use of these contingent mechanisms based on oil price, successful exploration or development success, for example.

Alignment of the stars

Finally, aside from the intervention of PE there are a number of other themes that need to be addressed when exploring deals, namely:

  • What is the value point for deal making? Is there now a floor (at least in the short term) and ceiling to the oil price? Is there risk of further short term price shocks and if there is, does this really matter? Which factors can undermine a price recovery in the medium term and for how long?
  • What will happen to the value gap? The value gap is at risk of widening if oil prices strengthen in early 2017. As prices recover, the expectation of the price point for sellers may well rise, but will buyers share this view. Does this mean there is currently a window of opportunity for deal making?
  • Timing – is now the right time to make deals? Will market conditions for 2017 continue to support a large number of opportunities? Is there a risk that if businesses don’t transact this year that opportunities will be missed?

So it is clear the oil and gas landscape is evolving rapidly, as deals materialise and are concluded. Companies will need to decide fairly quickly what they should do. Decisions around what to acquire, what to divest, and who to partner with can ultimately decide who will be the winners and losers once the landscape settles. Moreover, Private Equity has a major role to play in funding these transactions but will need to be diligent in its valuations to ensure deal risks are mitigated. And the big question remains - when is the optimal moment to transact? Is the window of opportunity just opening or beginning to close? Just like those London buses, you really don’t want to miss them when it’s raining.

[1] For more insights on deal activity in the US oil and gas market please refer to our publication US Oil & Gas Deals insights 2016

Contact us

Drew Stevenson

UK Head of Oil & Gas Deals, PwC United Kingdom

Tel: +44 (0) 7710 002801

Neil Leppard

Director, Transaction Services, PwC United Kingdom

Tel: +44 (0)7841 783 894

Adrian Del Maestro

Director of Research, Strategy&, PwC United Kingdom

Tel: +44 7900 163558

Wim Blom

Global deals lead, PwC United Kingdom

Tel: +61 (7) 3257 5236

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