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M&A Activity Sidelined as Entrenched Companies Watch Oil Price

The oil price required for natural gas and oil companies to be cash flow neutral in 2015 has dropped by more than $20.00 to $72/bbl following the industry's aggressive cost cutting measures, according to Wood Mackenzie Ltd.

However, more cutting still may be needed to achieve cash flow neutrality if oil prices hover at current levels, analysts said. For some operators, this could require selling assets, while others suspend or limit dividend and share buybacks.

"Capital cost cutting has been both rapid and in some cases dramatic," said Wood Mackenzie's Tom Ellacott, head of corporate upstream analysis. "Individual companies have had one, two and sometimes three bites at the cherry, and industry has for the time being settled on a 24%, or $126 billion fall year-on-year. Dividends and share buyback programs have also been targeted, while companies have turned to both the debt and equity markets to boost liquidity."

Two peer groups are "particularly interesting," he said. "For the majors, cutting or suspending buybacks have been the key levers, which have contributed to a 25% reduction in cash flow breakevens. For the smaller North American onshore players, the ability to rapidly dial back spending has been a key competitive advantage. Some players have cut costs by up to 80%, and these companies join a select group with cash flow breakevens below $60/bbl."

Stock market performance of late appears to indicate that many investors now are bullish on an oil price recovery. However, Wood Mackenzie's researchers found that a period of sustained oil prices at $60/bbl would require more action to conserve cash.

"The first quarter results will underline how much still needs to be done if oil prices do not continue to recover," Ellacott said. "More cuts to dividends and buybacks are likely if $50-60/bbl prices persist." Quarterly earnings results for the oil and gas industry get underway this week, with among others, Kinder Morgan Inc. reporting Wednesday and Schlumberger Ltd. reporting on Friday.

Opportunities are particularly tantalizing for the "financially strong," said Ellacott, evidenced by Royal Dutch Shell plc's mega deal this month to acquire BG Group plc (see Daily GPIApril 8). Wood Mackenzie's analysis found a huge inventory of assets is now on the market, with an estimated 340 potential merger and acquisition (M&A) deals worth more than $300 billion total. However, activity to date has been almost nonexistent.

"Buyer and seller expectations remain far apart, and buyers of material size are limited to the most financially secure," said Ellacott. "But a buyer's market in M&A might emerge as companies are forced to sell assets to balance the books. The $300 billion question is: with Shell having made the first move, who will follow?"

Investors likely "will be watching the upcoming first quarter results season for indications of how effective the reaction to oil prices at below $60/bbl has been," he said. "Companies are facing a choice of paring back investment or maintaining momentum throughout the cycle, depending on their financial position.

"There is a high degree of optionality regarding planned spend in 2016 and 2017, much of which is discretionary. How companies react to this strategic challenge will affect their production growth and positioning in the future."

For the first quarter, Evaluate Energy estimated the value of global upstream M&A fell to $7.1 billion, 79% lower than a year ago and a drop of 85% compared to the average value per quarter since the start of 2009.

"Potential acquirers are looking to now opportunistically buy assets at much lower prices but with the current owners of the assets seemingly of the opinion that the oil price is way below fair value, an impasse has been reached," Evaluate's researchers said.

"In the medium to long term, commodity prices will inevitably return to a semblance of levels seen in the past five years as cuts in exploration and development drilling translates into a restoration in the oil price, closer to the required break-even level to sanction new development projects," said Evaluate's Eoin Coyne.

"For any well-capitalized company, this quarter could have been seen as a rare opportunity to acquire oil assets at a steep discount to historical levels. However, with sellers seemingly of an opinion that the oil price is lower than fair value, an impasse has been reached, resulting in the lowest value quarter for oil and gas deals in the seven years that Evaluate Energy has been tracking all global oil and gas transactions."

North America's unconventional industry, which has been cited "as one of the chief instigators of the falling oil price," has been one of the first sources of supply to be hit.

"The effect of the price downturn on M&A in the shale industry has been a quarter with the lowest amount of shale deals since 1Q2009 of $0.4 million, compared to an average quarterly value of $8.9 million over the past five years," according to Coyne. "Even though the oil price is resting at attractive levels right now for buyers, it's clear that this quarter has come too early for many to make opportunistic acquisitions. Companies will doubtless feel the squeeze as time goes by and 2Q2015 will inevitably be a time when we see an increase in distressed sales as debt-laden companies have their hands forced by the need to furnish debt."

According to a report by GlobalData issued on Wednesday, global M&A values in the upstream decreased to $829.8 million in March from $2.9 billion in February. The Shell-BG merger "will have a positive impact on next quarter in terms of the total value of deals announced," but "the number of deals will remain low," said GlobalData's Matthew Jurecky, who heads oil/gas research and consulting.

The firm's latest monthly upstream deals review indicated that oil and gas companies spent most of their capital in March on Americas-based companies, with a total of $703.7 million.

However, deal volume was down with only 10 transactions announced in March, versus 11 in February, Jurecky said. The top deal in March was Canada's Whitecap Resources Inc.'s bid to buy fellow Canadian explorer Beaumont Energy for $459.8 million. Beaumont is a Western Canada explorer whose assets now produce 5,100 boe/d, nearly all liquids.

The GlobalData review found that financing through equity and debt offerings, private equity, and venture financing totaled $30.6 billion from 78 deals in March, versus February's total of $12 billion.

Most of the March investments were from the debt offerings market, which accounted for 70% of the total investment, at $21.4 billion in March. In February, there was $7.5 billion in debt offerings. In terms of the number of deals, equity offerings accounted for 60% of the total, with 47 in March.

"More capital was raised in March than in any month of the last year, and debt markets continue to register high levels of activity," Jurecky noted. "Increasing levels of debt could eventually prove challenging for some, should low crude oil prices continue much longer."

Deloitte LLP researchers, led by John England, U.S. oil and gas leader, said operators are adopting a way of thinking about investments.  In a 24-page report issued this week, "Following the Capital Trail in Oil and Gas: Navigating the New Environment,"  Deloitte's team studied more than 39,000 publicly listed companies across the globe, reviewing annual net equity (equity raised minus share buybacks) and net debt (long-term debt issued minus long-term debt retired). The research included 1,375 North American energy companies involved in exploration/production, refining, oilfield services and power and utilities.

"The fall of $50/bbl and a bearish outlook have diminished the allure" that the oil and gas industry had held for investors over the past five years, England noted. "They have all of a sudden changed the discussion in the sector from raising capital, to driving growth in the long term, to seeing capital as the biggest lever of adjustment in today's low-priced, cost-focused, and highly competitive market environment.

"Navigating this new environment might be painful for many" operators, but "they understand from past experience that adapting will only make them more efficient, dynamic, and innovative. The environment may question their traditional capital strategies and present several new capital choices, which will likely force many to explore and consider new forms of sourcing, deploying and optimizing capital."

The new strategies may include sourcing capital through low-cost investment vehicles; deploying capital in assets and markets that offer more portfolio and operational flexibility; and optimizing capital by adopting "leaner designs" and more agility in their supply chains and contracts.                                                                               

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