By OGJ editors
HOUSTON, Dec. 1 -- Energy merger and acquisition activity likely will rise in 2006, PricewaterhouseCoopers LLP's transactions services group said, noting that energy M&A has retreated from heights reached in the 1990s.
"We think it's very possible the industry will see some large M&A deals next year, both in the US and globally," said group leader Rick Roberge, Houston. During 2005, many oil companies repurchased their stock rather than making acquisitions.
"Many of the larger companies have been content to sit on their cash war chests in 2005," he said. "But at some point, commodity prices will settle, and companies will begin drilling higher-risk projects using higher midcycle prices. That's when consolidation will accelerate because of the need for larger balance sheets to reduce those risks."
Few companies believe current commodity prices are sustainable, he said. As prices soared for 2 years, investment as a share of cash flow at the 20 largest oil and gas companies fell to 36% from 46%. While investment levels are higher at independents than at integrated companies, the pattern was the same at both.
Integrated companies are likely to continue avoiding major acquisitions while commodity prices remain at record levels, he said. But independents are likely to begin increasing their acquisition activity, if only because they need bigger balance sheets to offset risks associated with drilling harder-to-access, potentially less productive resources.
Roberge said virtually no company based its budget on sustained high commodity prices, and now most companies have excess cash.
"As a result, companies have put balance sheet finance decisions ahead of investment decisions," he said. "While buying back shares is clearly preferable to raising dividends as a means of returning excess cash to investors, both are up this year as a percentage of cash flow."
Roberge said share repurchase programs are more flexible and can be reversed quickly, while a decision to increase dividends cannot.
"The M&A wild card is the global buyer," he said. "Often financed in part by their respective governments, national oil companies are not afraid to do deals at current price levels. Until M&A prices begin moving off their record highs, NOCs could be the most active players in the major deal marketplace."
Roberge said analysis of the 20 largest oil and gas companies through the first half of 2005 revealed that investment levels dropped as a percentage of cash flow despite a public clamor for more US supply and for more refining capacity.
"Energy investment is a long-term proposition, and the majors simply do not adjust their plans on 1-2 year commodity price cycles," Roberge added. "However, by now, higher midcycle prices should have brought more projects into the 'acceptable rate of return' zone."
