WoodMac: Private equity not a panacea for upstream M&A market

Public companies are under increasing pressure to decarbonize, bringing more upstream assets to the market but also thinning the pool of traditional buyers. Private equity could play a role in the merger and acquisition market, but it’s not a remedy for all, according to Wood Mackenzie analysis.

Following the 2014-2015 downturn was a surge of private equity entrants in places like the North Sea. While returns have been mixed, there’s speculation that private equity, less encumbered by public investors pushing for ESG progress, will see opportunities and surge into the sector once again.

In North America, there is an opening for privately held operators to drill high-return acreage at a time when public companies are not increasing production, despite high prices. Early evidence bears this out. In the Permian basin, the percentage of wells drilled by private companies soared in 2021.

Colgate Energy, backed by Natural Gas Partners (NGP) and Pearl Energy Investments, made two Permian acquisitions last year. Grayson Mill, backed by EnCap Investments, purchased Equinor’s Bakken position. Sabalo Energy II received a $300 million commitment from Encap to build an unconventional portfolio, and Warwick Investment Group is spending $450 million to buy and develop Eagle Ford assets. International opportunities also exist, but there are concerns, according to WoodMac.

“While the energy transition and ESG will force lots of assets to market, it also muddies the value proposition. It increases uncertainty around oil and gas valuations, while new energies and associated industries offer a huge alternative investment opportunity.” said Greig Aitken, research director at WoodMac.

Asset selection

“This creates a significant exit route issue. In the past, private equity has typically sold assets to three distinct peer groups: publicly listed E&Ps, NOCs, and to other private equity. There are concerns over the future appetite of all three in this space. In short – the list of buyers willing to take on upstream assets is shrinking.

“Plus, of course, ESG matters to private equity, and not solely because of exit routes. Some private equity funds are feeling direct ESG pressure from their ultimate owners – the limited partners. These backers often include institutions such as pension funds, many of whom increasingly have their own net zero trajectories,” Aitken said.

“Opportunities may well abound, but private equity will be very selective in its choices and could drive a hard bargain. For reward to outweigh risk, private equity will be looking for keen prices and cash-generative assets. Development projects don’t fit the bill. Marginally economic projects won’t satisfy requirements. Historically successful oil and gas investors will continue allocating capital to good value opportunities. But new entrants, and investors who have struggled to generate adequate industry returns in the past, are unlikely to flood into the sector. For sellers looking to exit vast non-core positions, private equity buyers might be an option, but they’re unlikely to be a panacea,” he continued.

“Our conversations with private equity players identified quite a mixed response to the upstream opportunity. However, on balance we do think the industry is likely to move into a wider pool of private ownership. In the US, family-owned businesses such as Mewbourne and Endeavour have gained a significant foothold. While international examples are far fewer, the emergence of similar privately held structures seems inevitable.”