Survey indicates deals on the upswing after a tepid 2013.
Oil and gas executives expect a steady stream of merger and acquisition activity in 2014 as their companies consolidate core businesses and eye access to new technology and geographic growth, according to a recently released KPMG survey of oil and gas M&A activity in 2014. Of the 100 oil and gas executives surveyed, 56% expect their company to initiate an acquisition this year, and 39% expect to initiate a divestiture.
The KPMG M&A outlook survey indicates the desire to consolidate core businesses will be the primary driver of oil and gas M&A in 2014, followed by access to new technologies, geographic growth, product and service growth, and customer growth.
"Companies continue to rebalance their asset exposure, concentrating development resources in liquid-rich plays like the Eagle Ford and Bakken [shale plays] and areas with adequate midstream infrastructure, logistics, and market access to support near-term profitability and growth," said Tony Bohnert, KPMG's energy sector lead partner for transactions and restructuring. "We're also seeing a wave of deepwater M&A activity in the Gulf of Mexico as companies look to boost production as fields mature and further expand geographic and geologic diversity."
Fifty-seven percent of oil and gas executives expect the United States to experience the highest level of M&A activity in 2014, followed by Western Europe (27%), and China (26%).
"The perceived safety of the United States, and North America more broadly, continues to attract investment dollars from both US and global companies looking for predictable growth in today's volatile economic environment," said Bohnert. "However, as capital continues to flow into the North American market, it is increasingly being allocated to the exploration and development of existing holdings, partly at the expense of M&A activity. We're also starting to see a drop-off in joint venture activity from foreign investors as national oil companies (NOCs) have quickly advanced their knowledge about how to apply North American fracking techniques and technologies."
Reasons for pessimism
Eoin Coyne, a senior analyst with Evaluate Energy, is a little more pessimistic. He said the recent absence of major Chinese involvement and eroding profitability in the oil and gas industry has led to M&A reaching just $33.4 billion in the first quarter of 2014, 28% lower than the average quarterly M&A spend over the past three years. The lower M&A value is also mirrored in the deal count of 205 deals during the quarter (excluding licensing rounds), which is 27% lower than the average deal count by quarter since 2010.
Since the start of 2010, state-influenced Chinese companies have been responsible for $95 billion of company-to-company oil and gas deals at an average spend of $5 billion per quarter. In Q12014, these companies accounted for only $147 million of upstream deals.
Coyne continued, "It is likely that this relatively low amount of activity is more to do with a timing issue rather than a shift in strategy from China, especially with Chinese companies rumored to be interested in acquiring large stakes in the LNG industries on Canada's west coast and in Cyprus during the quarter."
Evaluate Energy's Coyne added that, "The more significant factor in the relatively lower M&A total is likely to be the continued drop in profits for the upstream industry as a whole."
He noted that industry profits as a whole are 25% lower than in 2011 and 16% less than in 2012. This is reinforced by the latest OGJ150 quarterly report in this issue (p.52) that shows a continuing decline in both total revenues and net income over the past few quarters. Revenues for the 121 reporting companies were down 4% from the previous quarter and 9% from the final quarter of 2012, while net income for 4Q2013 plummeted 18% from the previous quarter while declining only 1% from the same quarter in 2012.
"The underlying reason behind the erosion of profits is the escalation of operating and development costs in the oil and gas industry, which haven't been reflected in the oil and gas price realizations," said Coyne. "Therefore, profits and free cash flow have been squeezed and companies have been more tentative with their capex budgets."
Challenges to dealmaking
The KPMG survey cites several factors that could adversely affect deal activity in 2014, including the regulatory environment (38%), valuation disparities between buyers and sellers (37%), volatile energy prices (36%), and the inability to forecast future performance (28%).
"Lingering uncertainty around state and federal environmental regulations and local political will around future development remain considerations for companies as they look to emerging plays," said KPMG's Bohnert. "In addition, the gap is still wide between what buyers are willing to pay for producing assets and what sellers think they are worth. Many buyers do not see an upside to paying a premium for properties already in production, and instead are setting their sights on early-stage assets."
Survey participants indicated there will be very few megadeals in 2014, with middle-market deals dominating M&A activity. Fifty-six percent of respondents said they expect their respective deal activity will be valued under $250 million, followed by 23% who anticipate their acquisitions will be valued between $250 million and $499 million, and 11% between $500 million and $999 million.
"Positive economic indicators, such as an abundance of available private equity and financial capital at low interest rates, an expanding economy, and recovering employment figures, point to an attractive M&A market," said Bohnert. "Although long-term uncertainty has kept CEOs and CFOs focused on cleaning up their portfolios in recent years rather than exposing their companies to significant risk with large-scale deals, an increasing pursuit for M&A opportunities could be on the horizon.