M&A in the post-Macondo landscape

Before the April 20, 2010 blowout, the Deepwater Horizon drilled one of the deepest wells drilled by the industry at 35,055 feet. Photo courtesy of Transocean

Walter Cumming, Barclays Corporate Bank, London

Amid the uncertainty of the last few years, energy businesses have been prudently waiting out the storm, preserving their cash and deleveraging. With confidence now returning to the marketplace, organizations are looking at ways to use their strengthened balance sheets to exploit the recovery and improve their market position.

Those with access to funding are eager to tap into viable long-term growth prospects. While the £1.8 trillion (USD 2.9 trillion) worth of global M&A deals across all sectors in 2010 is still well below the record £2.9 trillion (USD 4.7 trillion) recorded in 2007, the trajectory for 2011 is positive.

Specifically in the energy sector, the oil price rose during the year, which has resulted in steady growth and growing optimism in the industry.

As we move through the next 12 months, companies will be making decisions in the context of not only this higher commodity price but will also be taking into account the potential tighter regulations in the Gulf of Mexico, unrest in the Middle East, and uncertainty over Japan's short- to medium-term hydrocarbon requirements.

Global M&A landscape

Specifically in North America, it's likely the next year will see more investment opportunities in areas such as exploration, despite predicted tougher regulation following incidents such as the Macondo well blowout in the Gulf of Mexico on April 20, 2010.

Geographies including offshore Brazil are also increasingly becoming a focus for organizations and shale gas will likely be positioned in the longer-term as a transition fuel.

There will realistically be significant changes post-Macondo, particularly to the US regulatory framework. Questions will no doubt be asked around the cost of change, and it's likely we'll see companies look to form partnerships and joint ventures to mitigate this risk and indeed spread this increased outlay.

With the landscape changing there are also likely to be opportunities for companies looking to invest, particularly those with access to funding.

Longer term, expected new environmental and safety regulations will increase the cost of exploration and production and impact on investment prospects. Tighter regulation in the United States, perhaps more in line with the type of legislation already evident in the North Sea, may price some of the smaller players out of the market and lead to more M&A activity.

In response to this, companies will need to revisit risk and business strategies and perhaps even change course to ensure they are best placed for success in the new landscape.

That said, the predicted rise in the commodity price will further drive investment, acquisitions and project development as it allows companies to better plan activities.

This higher price will encourage exploration and production, particularly in marginal assets. Markets are likely to continue to be open for the right transactions and fewer delays are expected in capital expenditure decisions.

More stringent regulation can signal good news for some companies and there will be a positive impact on many service sector activities, particularly those in the safety, inspection, maintenance, and repair areas. This translates to increased costs for E&P companies, which may also drive increased M&A activity as players look for scale benefits.

We would expect the shape of the company base in the industry to change. Smaller operators could cease to exist in their current form, with increased M&A for service companies also a realistic outcome.

"Tighter regulation in the United States, perhaps more in line with the type of legislation already evident in the North Sea, may price some of the smaller players out of the market and lead to more M&A activity."— Walter Cumming

In the United Kingdom, we do not expect to see the ongoing steady program of divestment in the North Sea by majors to abate but the recent increase in petroleum revenue tax at the March Budget will probably create at best a hiatus where both vendors and buyers take stock, rerun their investment models and ponder whether the growing pressure on the chancellor will bring about concessions. This is particularly true of gas assets, which have been hit hard by the changes.

Tighter lending

Our approach to the sector has always been well balanced and is demonstrated by our track record, lending well and avoiding losses. We have maintained this approach consistently, and in 2010, Barclays corporate oil and gas team lent USD 1 billion of new money to a mix of clients across the world.

The bank completed a number of deals in the US, Asia Pacific, Middle East, and UKCS with companies including Acergy, FMC Technologies, Ensco plc, Oil States International, and Wood Group. The finance has been used for different activities, for example M&A, abandonment liabilities, and corporate funding, and includes bonds, revolving credit, and term loan facilities. However, that doesn't mean the sector has stayed the same — or indeed won't change.

There's no doubt that lending has become tighter across some parts of the industry and stricter regulation will make an impact on the shape of the sector in the Americas.

That said, Barclays Corporate is today increasing its lending to the sector significantly, but there remains a rigorous credit and business case regime with a robust due diligence process to navigate. Nonetheless, companies with good propositions and a diverse portfolio remain the most likely to receive funding.

What that means is lenders will be best disposed to organizations that actively look to manage the risks in their business and that are moving towards a more diverse portfolio, both in terms of activities and geography.

Companies can do a lot to improve their attractiveness to lenders, including building the balance sheet, raising equity, deleveraging, diversifying risk, and growing in size. They should look at banks that can provide more than just debt, but can add value in other areas such as foreign exchange, bonding, hedging and investment banking.

Hedging in the current environment

Finally, many companies are currently debating the merits and demerits of hedging in a high commodity price environment. It is tempting to think only in terms of the upside for prices, especially when we consider the current pressures on supply and the ever-increasing world demand for oil but it's only been three years since we witnessed $40 oil.

There were few analysts predicting that sort of price crash in 2008. There are attractive hedging solutions (some at zero cost) that take the downside risk away in investment decisions but at the same time leave reasonable upside potential. Now is certainly a good time to look at what's available.

Current trends suggest well-managed companies are cognizant of this, which is particularly relevant as we head towards 2012 and a potential "wall of credit." 2007 was the height of the booming market and most companies took advantage of typically five-year debt and favorable pricing.

These deals will need refinancing in 2012, and this will coincide with tighter bank regulations and improving economic conditions. Companies should consider acting early in 2011 to get ahead of the market.

Going forward

There is generally an improved economic outlook for the industry with more financing options available, which is likely to result in increased M&A activity.

We do not know the exact range and impact of tighter regulations, but they are likely to create specific challenges that businesses need to address, ensuring they are best placed going forward.

Energy companies with the right business model to meet these challenges will succeed, but for the smaller players, operators specifically, who are unable to adapt, it may well be a difficult year. OGFJ

About the author

Walter Cumming is head of the oil and gas group at Barclays Corporate Bank in London. He has more than 30 years of banking experience in the UK and US. He has been involved in oil and gas finance for around 20 years both during his time in New York and in various roles in the UK including credit, leveraged finance, and corporate banking. He is a Chartered Banker and has an MBA from Edinburgh University. Having spent the previous 10 years based in Aberdeen, Cumming is now based in London where he has recruited a new team to cover the oil and gas sector for Barclays. He continues to manage the Aberdeen team as well. He has been involved in many significant deals in the sector over the years including BJ Services, Energy Cranes, Petrofac, Venture Petroleum, Wood Group, and Acergy.

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