Bullish opportunities in a bear market

Jason Reimbold
PLS A&D Group

Economic uncertainty, increasing unemployment, high volatility of commodity prices, slumping oil and gas consumption, and limited access to capital are a number of factors that have fostered the bearish sentiment that has permeated throughout our industry for much of first quarter 2009. Nevertheless, conditions may be shaping up for those willing to take advantage of this seemingly dismal situation.

M&A activity in the sector is down from the peak of last year, and many analysts expect this slump to continue throughout 2009. There will likely be few mergers, save mergers of necessity, thus transactions for the remainder of the year should be dominated by asset sales and consolidation among junior oil and gas companies.

Over the last couple of quarters, closings on asset sales slowed as commodity prices plummeted from 2008 highs. However, volatility, more so than lower prices, has made it difficult for parties to agree on asset valuation. Nevertheless, there is one factor suggesting a more optimistic outlook that could result in a number of deals finding their way to market in the coming months.

For some companies that levered production at higher 2008 prices, the impact of declining commodity prices over the last eight months could push their debt to EBITDA ratio beyond the limits on their loan agreement. In fact, a recent KPMG report stated that debt to EBITDA ratios for select public oil and gas companies have increased, on average, from 0.34 times to 0.48 times. This is not an alarming number, but it seems reasonable to speculate that this ratio could be significantly higher for many smaller private companies. Although many banks will work with clients to preserve the relationship and salvage the account, exceedingly leveraged companies may be forced to liquidate assets in order to service debt. In this regard, creditors may be a driver behind numerous asset sales in the near—term, and their involvement may influence sale prices in way that is likely to attract buyers. Consequently, the industry may see an acceleration of deal flow and closings despite continued volatility in commodity prices.

Companies that were conservative with debt during the time of record prices last year could be well positioned to capture upcoming acquisition opportunities. However, motivated sellers alone will not be enough to facilitate successful closings. Buyers will need access to capital.

While many capital providers continue to stay on the sideline, there are a number of firms still actively pursuing investment opportunities. In fact, I receive several calls a week from capital providers proactively seeking funding opportunities. Of course, the deal has to make sense, and the necessity for having a strong management team in place to operate the asset goes without saying, but it means deals can still get done. Also, the flow of capital will hopefully ease as the anticipated stimulus package ripples through the economy.

Ultimately, the long—term outlook for the industry is positive. At the time of publishing, oil and gas prices were still in contango with 2011 pricing at $61.00 for oil and $7.18 for natural gas, and long—term consumption estimates are favorable as well. The challenge will be to maintain liquidity while capturing opportunities.

The next six to nine months could be an excellent time for management teams to focus their efforts, take advantage of value—priced acquisition opportunities, and position themselves for the next uptick.

About the author

Jason Reimbold serves as the Director of Capital Markets for the PLS A&D Group (www.plsx.com). In 2005, Reimbold founded www.GlobalOilWatch.com, an energy research portal for industry analysts and investors. In 2007, he co—authored The Braking Point: America’s Energy Dreams and Global Economic Realities (www.thebrakingpoint.com) with Mark A. Stansberry.