FOR THOSE WITH THE CASH, THE DOWNTURN WILL PRESENT SIGNIFICANT VALUE OPPORTUNITIES
RANULF COULDREY, TRBP LTD., LONDON
Despite the general sentiment that a reduced oil price will cause an upsurge in oil and gas merger and acquisition activity, the form that this increase will take will represent a seismic shift in the themes of upstream transactions. On the corporate side, analysts are predicting another big deal in the same vein as the Repsol/Talisman and Halliburton/Baker Hughes transactions. On the asset side, though, we may well see the reversal of the trends that have emerged over the last decade.
Wood Mackenzie, in "What to Look for in 2015," claims that low oil prices means "a true buyers' market could emerge." Six months previously, Deloitte was saying the same of oil at greater than$100/bbl, arguing for a "rise in deal activity in the second half of 2014" following a half in which "oil continued to dominate upstream deals, thanks to continued strong crude prices." Evercore saw a "market weighted in favor of buyers" back in July 2014.
Arguably they were all right. Arguably it's always a buyers' market. In an industry as capital intensive as oil and gas, funding is always an issue, and those with the cash always have a choice of comparatively "low hanging fruit" in both the upswings and downturns. But while the last decade's asset transactions were fueled by programs of divestment by the majors, acquisitions in the current climate are likely to take a different shape.
Even at $100 per barrel, a large proportion of projects have been uneconomical for the larger IOCs. Over the last decade, operating costs have risen by 300% while production has only risen by 12%. For the super-majors only the largest of margins (more and more often provided by mega-projects with greater than$1billion in CAPEX requirements) can cover soaring G&A and operating expenditures. This led Shell to announce last year that one third of its portfolio was making a neutral return.
The result of all this has been large-scale programs of divestment by large-cap operators. Before the proposed merger with Royal Dutch Shell, BG announced its intention to monetize 50% of its portfolio. BP has divested more than $42 billion in assets (although there are clearly other influences at work here). Total announced in September that it will divest $10 billion in assets by 2017, and Exxon Mobil announced a policy of "investing for the sake of capturing value."
The buyers of these assets have been a new generation of smaller IOCs pursuing mature or marginal fields that are, for them, highly profitable. Smaller companies have smaller operating costs and are "easy pickings" for less-burdened companies. This has resulted in a fragmentation of the oil and gas corporate landscape. Over the past decade, $1.6 billion has been raised in 115 IPOs on the AIM by E&Ps compared to $503 million by 49 operators in the previous 10 years.
The North Sea in particular exemplifies this trend. Rising costs caused Chevron to reconsider a final investment decision on the $10 billion Rosebank development back in 2013, and Statoil divested more than $5 billion in assets from 2011 to 2014.
As a mature basin, the North Sea not only has a large number of potential targets for enhanced oil recovery opportunities, but also a highly developed subsea infrastructure that enables smaller discoveries to be tied back to existing developments to minimize CAPEX requirements.
The trend is demonstrated by the change in drilling activity. From 2003 to 2013 there were, on average, 18 exploratory wells drilled per year, down from 43 in the previous 10 years, and 91 in the decade before that. Though the number of development wells has likewise fallen as the basin matures, the ratio of development to exploration wells has risen from 3:2 to 9:1 over the same time frame. Producing assets have drawn the most investment.
Outside the US, the North Sea is also one of the major areas of private equity vehicles targeting incremental or technically difficult projects. Bridge, Chrysaor, Alpha, and Spike have all entered the market in the last eight years targeting producing or complex assets. Similarly, Southeast Asia also has been a pool for private capital with majors neglecting the area after a lack of major discoveries since 2001. Kris Energy (set up by First Reserve in 2009) recently acquired Chevron's interest in the Aspara field, and Tamarind was set up by Blackstone in May with the explicit aim of targeting "producing assets in proven plays".
Acquisition of producing assets from large-scale divestment programs has therefore dominated the upstream M&A sector in recent years. In 2014, 95% of working interest acquisitions were for "established" assets - those either producing, or in development. Nevertheless, it seems unlikely that these divestments will continue into 2015 in a lower price environment.
Though value and capital allocation is obviously of only greater necessity under a reduced price, monetizing these assets at a discount is unlikely to be the best route for portfolio rationalization. Unless contractual or legal constraints force their hand, larger operators are likely to delay divestments.
Capital spending delays have already been announced. Shell is deferring $15 billion of 2015 expenditures, and Exxon and ConocoPhillips are reducing capex budgets by 13% and 33%, respectively. If companies are delaying the development of assets that probably would come on-stream after some sort of supply/demand equilibrium has been reached, divesting assets at a time of a supply glut would be poor judgement.
The same may not be true of smaller IOCs in development stages, as access to capital dries up. Without the funds to wait-and-see, dependent, in many cases, on one or two assets, the decision to go ahead is not a matter of choice. Their ability to do so, however, will be less clear-cut, as their options for funding dry up.
Capital belt-tightening is already evident. Trap Oil recently relinquished its 13million-barrel net interest in the North Sea Orchid project, having been unable to find a partner to help develop the technically difficult chalk reservoir. In 2013 it had bought a 45% interest for 30 cents a barrel.
Issuing equity seems an unattractive source of funds. Indonesian-based Samudra has already postponed its IPO, and it is unlikely that the AIM will see any but the most desperate and the most fortunate go public in the current price climate. Similarly, while private equity accounted for 20% of transactions over $1 billion in 2014, the industry as a whole is an unattractive investment at the moment, even if volatility rather than marginal cost is the main detractor.
Debt will prove even more problematic. Credit facilities were due for re-examination in April, and available drawdowns are likely to be slashed as assets and borrowing bases are written down. Highly leveraged companies will be faced with the unavailability of funding to development their assets, but the necessity of production to service their debts. Over the past five years, the industry has drawn down over $1.2 trillion in credit, and a rash of upstream companies can't be far away from a wave of defaults and Chapter 11s.
Going forward, M&A activity is unlikely to see a great number of marginal EOR acquisitions, or risky "upside" gambles. What was marginal for a major is now marginal for everyone. With Brent crude prices greater than$70 per barrel, it is hard to see sellers being particularly motivated, unless otherwise pressured by working capital requirements. The acquisitions that do occur are likely to take the form of "white knight farminees" - cash rich players supplying development capital under highly favorable conditions to smaller IOCs in a bind.
For those with the cash, the downturn will present significant value opportunities, and the industry may see a reversal of the trends of the past decade - the cash-rich majors rationalizing their portfolios through strategic acquisitions and diversification, rather than divestments.
ABOUT THE AUTHOR
Ranulf Couldrey is a commercial analyst at TRBP Ltd., an upstream oil and gas consultancy, specializing in Europe and North Africa. Prior to this, he worked in oil and gas-focused private equity. Couldrey has a postgraduate degree in law and a diploma in petroleum economics. He is a member of the Society of Petroleum Engineers.
