M&A deals decline globally except in US and Canada

Past year's results

Fueled by national oil companies and international buyers making acquisitions in North American shale gas, shale oil and tight oil basins, global transactions involving unconventional oil and gas resources reached a record high $75 billion in 2011, according to the IHS Herold 2012 Global Upstream M&A Review, recently released by information and analytics provider IHS. This figure represents 48% of total 2011 worldwide upstream M&A spending.

"Cross-border buyers, led by Asian-based investors, continued to stream into North American unconventional resource plays through asset partnerships and select corporate deals, with a bullish view on potential LNG exports to the Asia-Pacific region in the coming decades," said Christopher Sheehan, director of energy M&A research at IHS. "In 2011, high crude oil and international gas prices were juxtaposed against persistently depressed North American natural gas prices, leading to a 15-year high in deal counts outside North America."

Total global upstream M&A transaction value, including corporate mergers, fell 30% from an all-time high in 2010, which was driven by massive asset divestiture programs. Corporate deal value in 2011 rose 19% to more than $58 billion, including BHP Billiton's $15 billion takeover of unconventional resource-focused Petrohawk Energy, the first upstream corporate merger greater than $10 billion since the ExxonMobil-XTO deal in late 2009.

In the international gas markets, growing Asian LNG demand will increasingly fuel merger and acquisition activity from Australia to East Africa. In these regions, Sheehan believes small-cap international E&Ps that own huge resources but lack sufficient development capital will increasingly be takeover targets, particularly as the European debt crisis has impacted their access to and the costs of capital.

"Established shale gas and emerging shale oil and tight oil plays in the US are attractive to foreign buyers since these plays offer massive discovered resources with low exploration risk in a country with relatively high political and fiscal stability, versus other global regions such as the Middle East, Africa and Latin America," said Sheehan. "The longer-term potential of LNG exports to the Asia Pacific from Canada and the US is a strategic driver of many of the cross-border shale gas acquisitions in North America."

Added Sheehan: "We believe that, in the present volatile environment, global upstream M&A consolidation will accelerate in 2012 and beyond as the well-financed 'haves' prey on the capital-constrained 'have-nots.' Many of the latter are key holders of massive undeveloped gas and liquids resources that can provide material growth opportunities or establish a strategic foothold in emerging basins. Consolidation, including a rise in corporate takeovers, will be led by national oil companies and sovereign-wealth funds, major integrated companies, global industrial conglomerates, and private-equity investors, who all seek opportunistic purchases of capital-intensive oil and gas assets and financially strained companies that own prolific resource potential."

Private equity activity

Private equity (PE) interest in the US oil and gas industry marked at least a 20-year high during the first quarter of 2012, as the volume of mergers and acquisitions reached 11 transactions, which had a total deal value of $11.5 billion, a 120% increase in activity when compared to the same period in 2011, according to PwC US.

For the first quarter of 2012, there were 44 oil and gas deals with values greater than $50 million, accounting for $34 billion in deal value, which was essentially unchanged from the 45 deals representing $34.6 billion during the same period last year. However, there was a small uptick in first quarter average deal size in 2012 to $773 million from $768 million during the first quarter of 2011, driven by nine mega deals (deals with values of $1 billion or more).

On a sequential basis, deal volume in the first quarter of 2012 dipped from the 48 deals in the fourth quarter of 2011, with total deal value in the first quarter this year seeing a significant decline from the $80.5 billion from the previous quarter - a 58% decline quarter-to-quarter. The decline in deal value, according to PwC, can largely be attributed to depressed natural gas prices.

"Although deal activity has remained consistent year-over-year, we are beginning to see a softening of deal flow when compared to the past few quarters," said Rick Roberge, principal in PwC's energy M&A practice. "This past quarter, however, was a watershed moment for private equity activity and we're seeing an increased appetite from these investors to deploy their dry powder in oil and gas transactions. The 10-year low natural gas prices have attracted PE as they see opportunity getting in at the bottom and are taking a long-term view of natural gas pricing. Corporates, meanwhile, view natural gas plays at these prices as a challenge to the industry. And while a majority of PE activity has been in the upstream sector, we may see a trend toward growing investments in the downstream space with an eye towards refineries, an area which has had very limited activity."

There were 18 corporate transactions with values greater than $50 million, with a total deal value of $15.8 billion. Twenty-six asset deals contributed $18.2 billion, or 53% of total first quarter deal value. When compared with the first quarter of 2011, there were seven more corporate transactions in the first quarter of this year, although total deal value dropped from the $17.5 billion that was generated during the first three months of 2011. The number of asset transactions declined from 34 deals in the first quarter of 2011, but average deal value jumped 40% in the first quarter of 2012 to $700 million.

"International players are still investing in a major way through joint ventures in US shale plays as they're attracted to the country's stable economic and political environment and gaining the technology in shale resource plays. We believe that interest from foreign buyers will remain throughout 2012," added Roberge. "Another development that we believe will continue to get increased attention is the increase in permits for drilling in the Gulf of Mexico over the past year. Companies looking to gain exposure to conventional sources of energy are looking more closely at the Gulf for opportunities - and although M&A activity has been slow to come back in the region, the fact that permits are on the rise is evidence that the Gulf is back in business."

Enormous appetite for unconventional

John White of Houston-based Triple Double Advisors, commented, "Over the last 10 years, we've seen phenomenal growth in reserves from potentially a handful of internationally focused independents and that's been accompanied by reserve expansions in the US, mainly by large independents and super majors. The real marker we've had in the last couple of years was ExxonMobil's acquisition of XTO Energy in 2010 in order for them to acquire a significant position in North American shale and, of course, all the technical expertise that XTO had. Other major markers were Shell buying East Resources in the Marcellus shale and Chevron buying a large portion of Atlas Energy. The appetites of all these companies for shale and other unconventional resources is huge."

White added, "It's pretty well understood that the majors are way underexposed in North American shale plays, which so far are still dominated by independents, so I wouldn't be surprised to see an acceleration of this trend of shale acquisitions by the majors. This latest $600 million deal between Chesapeake and Exxon [in the Texoma Woodford play in Oklahoma] would seem to be a confirmation of that. Also, Petronas, the Malaysian national oil company, has said that it is looking for upwards of a $5 billion corporate acquisition of a Canadian company, although they did not specify which company they are interested in."

Asked about likely candidates for acquisition, White said, "We will probably see more acquisitions of smaller, gas-weighted companies by larger, financially-strong companies. On the oil side, I think you'll see a lot of activity from large companies wanting to acquire some of these independents that have had fantastic success overseas…Getting back to the US, I think you could see at any time another Exxon-XTO type of deal."

M&A trends

Maynard Holt , co-president and head of upstream banking for Tudor Pickering Holt & Co., told us, "About 90% of our buying customers are interested in liquids. But that's not a trend - that's not new. Over the last few years, as gas has steadily traded down, the percentage of people in the market who believe that it's coming back anytime soon has been going down every quarter. The people who talk about gas now realize they are making four-, five-, or six-year bets - maybe longer. They know there are a lot of opportunities out there, so they are going to be very choosy buyers.

Holt added, "Pick your part of the market. If you're in the Permian or the Bakken, those are great, hot markets for sellers. If you're in other liquids plays like the Utica, the Mississippi Lime, the Granite Wash, the Niobrara, etc., those are sellers' markets. If you're in gas, you want to be wet and as close to New York City as possible. If you're talking about the (Gulf of Mexico) shelf or deepwater, those are buyers' markets. So you end up with an extreme market that is tilted to one side or the other pretty strongly. I'm struck by how sharply the market is delineated."

Lance Gilliland, managing director and head of M&A for TPH & Co., said, "For someone to buy gas assets, the buyer would need to have a long time frame for his potential return on investment. You would need people with a long view, which means they would have to be well funded."

Gilliland added, "With respect to smaller independents that are heavily or solely dry gas, there is a divergence for companies in that category; companies that have strong balance sheets and a good, strong core position in the play versus ones with weak balance sheets and a not-so-good position. The guys who have weak balance sheets don't know how long their creditors will be patient and whether the banks want them to sell now or not. If [the banks] think the situation is only going to get worse, then they may force the company to do something. Companies with stronger financials obviously have more latitude."

Asked what impact geopolitical risk and the global economic malaise have on M&A activity, Holt was somewhat optimistic. "Our attitude is that when you feel the economic situation is poor, you buy oil. When you feel the economic situation is good, you also buy oil. That said, economic risk and political risk do impact M&A activity. Buyers want more clarity about what they're investing in. However, commodities are a hedge against inflation, so US oil starts to look particularly attractive in that situation."

Gilliland concluded, "If you're building a portfolio, you like to have a lot of that North American oil in it.