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U.S. E&P Dealmaking Slows, Even in Permian, as Private Equity Fills Void

U.S. upstream dealmaking slowed significantly during the third quarter, with transaction value falling to only $8 billion after a total of $86 billion in the previous four quarters, 1Derrick reported Wednesday.

Only 17 transactions for more than $100 million each were recorded between July and September, well below the average of 24 worth $100 million-plus from 2008-2016. In the previous four quarters, there was a total of $86 billion in mergers and acquisitions (M&A) in the domestic upstream, the oil and gas researcher said.

U.S. deal activity slowed in every region, particularly in the formerly red-hot Permian Basin, where transaction value fell to $1.3 billion from more than $40 billion in the previous three quarters.

However, an analysis by 1Derrick of U.S. private equity (PE) investment suggests another round of privately financed dealmaking and consolidation is on the horizon.

“After an intense 12 months of deal activity, producers turned their focus to enhancing the development potential of their core areas through acreage trades and operational efficiencies,” said 1Derrick COO Mangesh Hirve. “A decline in oil prices in 2Q2017 pressured capital budgets, which are expected to increase by an average 40% in 2017.”

Upstream investors, Hirve said, “face a conundrum” as internal rates of return for individual wells appear to be attractive, but “producers are still guzzling cash at a corporate level. Investors in public companies are looking at corporate cash flows and forcing managements to consider divestitures to raise cash for drilling.”

Meanwhile, “private capital is willing to take a more long-term view given the inherently strong economics of the best resource plays. As a result, more than 60 new companies have received capital commitments from PE firms so far in 2017.”

U.S. upstream M&A value averaged more than $20 billion per quarter from mid-2016 to mid-2017, driven by confidence in the long-term exploration and production (E&P) profitability of premier resource plays such as the Permian.

However, the West Texas Intermediate oil price, which averaged $53.47 in February, dipped below $50 in March and reached a low for the year at $45.18 in June.

“The $6.10/bbl decline in the average second quarter oil price generated average 11% declines in pre-tax operating income and cash flow for a representative universe of 42 major E&Ps,” 1Derrick noted. “Producers responded by taking steps to boost margins in core areas, especially by trading noncore and nonoperated properties for acreage that increased average working interests and expanding extended-lateral drilling opportunities.

“Thus far, companies have indicated their long-term confidence by largely remaining committed to their expanded 2017 capital programs.”

That confidence is shared by PE firms, which dominated the limited dealmaking during 3Q2017.

A major focus for M&A during the period was the Rocky Mountains, where Bruin E&P Partners, a portfolio company of ArcLight Capital Partners, in July agreed to a $1.4 billion deal to acquire Halcon Resources Corp.’s operated properties in the Williston Basin.

A second Rockies-focused deal was announced in July by Pinedale Energy Partners LLC, an affiliate of privately held Oak Ridge Natural Resources LLC. QEP Resources Inc. subsidiary QEP Energy Co. sold Pinedale Energy some Wyoming natural gas assets, including all of its Pinedale Anticline property for $740 million.

In the only other transaction for more than $1 billion, Houston-based Silver Run II, backed by Riverstone Holdings LLC, agreed to combine with Oklahoma-focused producer Alta Mesa Holdings LP and Kingfisher Midstream LLC to form Alta Mesa Resources Inc. Alta Mesa Holdings is backed by HPS Investment Partners and ARM Energy Holdings LLC.

The only major Permian deal done during the third quarter was a $732 million transaction by QEP, which applied proceeds from its Pinedale sale to purchase of Midland sub-basin properties from private sellers.

PE investment is playing a growing role in the U.S. upstream M&A. The E&P firms sponsored by private funding have to date this year accounted for more than $8 billion in acquisitions and $9 billion in divestitures, according to 1Derrick.

“More significantly, these investment entities have committed more than $11 billion to more than 60 new companies so far this year.”

The largest allocations have been Quantum Energy Partners, which has spent $2.5 billion this year to fund four new E&Ps; EnCap Investments, with $1.8 billion to back seven E&Ps; and Apollo Global Management, with $1.6 billion directed to four new E&Ps.

Two new companies received more than $1 billion in start-up equity commitment to date this year, Appalachia-focused HG Energy II, sponsored by Quantum, and Encino Acquisition Partners, backed by The Canada Pension Plan Investment Board.

Midcontinent-focused Chisholm Oil & Gas LLC received a $900 million commitment from Apollo, while Valorem Energy LLC got $300 million from PE giant Kayne Anderson. New PE-sponsored Permian E&Ps include Admiral Permian Resources LLC, which received $600 million from Pine Brook Partners and Riverstone, and EnCap-backed QStar II and American Resource Development, which received $400 million each.

This level of PE-investment is likely to trigger another wave of acquisitions and consolidation, according to Hirve.

“Many of these new companies are yet to make their first acquisitions,” he said.

The two most notable transactions to date, he said, were HG Energy II’s $1.3 billion purchase of Noble Energy Inc.’s Marcellus properties and Chisholm’s $625 million purchase in Oklahoma’s Sooner Trend of the Anadarko Basin, mostly in Canadian and Kingfisher counties, aka the STACK.

“We expect the remaining capital will be allocated in the next two or three quarters as public companies continue to raise cash through divestitures,” Hirve said.

Mergermarket also on Wednesday issued its global M&A roundup of 3Q2017 activity in the energy, mining and utilities (EMU) sector.

“Unfortunately, the slide of this sector continues,” said Mergermarket analysts. Even though oil prices rallied through most of the third quarter, EMU dealmaking continued to wane, “underlining a continued downward trend for deal activity in the space in 2017.”

EMU’s total global deal count was 316 transactions in 3Q2017, marking the sector’s lowest quarterly activity since 1Q2015 when there were 301 deals “and the slowest third quarter in six years” since 3Q2011, where there were 308 deals.

“Geographically, the U.S. still dominates the landscape, accounting for 33% and 55% of total EMU deal count and value over the last three months, respectively,” Mergermarket analysts said. “Asia saw the sharpest decline in value with a total of only $ 8.8 billion, down 45% sequentially and year/year.

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