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Higher Prices Expected to Temper Upstream M&A in 2008

The value of upstream global mergers and transactions hit a record in 2007 -- but don't expect a repeat in 2008 with current oil and natural gas prices, according to an analysis prepared by John S. Herold Inc. and Harrison Lovegrove & Co. Ltd.

Herold and Lovegrove's latest annual report, "2008 Global Upstream M&A Review," reviewed more than 330 significant upstream mergers, acquisitions (M&A) and divestitures that were announced in 2007. After the price of M&A and sales accelerated to consecutive record levels in 2005 and 2006, worldwide weighted average pricing for proved reserves actually fell 22% last year to $9.99/boe, the study noted. In North America, implied proved reserve (1P) values declined a moderate 7% to $16.57/boe.

Still, the value of global asset transactions rose almost 40% to $89 billion in 2007, according to the study. Asset transactions jumped 30% to more than 240, with more than 90% in the sub $1 billion segment and nearly 75% in North America. Global corporate transaction value declined to $65 billion as no deals of more than $10 billion were transacted for the first time since 2004. Instead, transactions were driven by a surge in the "smaller" $5-10 billion segment, which surged from $5 billion in 2006 to nearly $34 billion last year -- representing more than 50% of total corporate deal value in 2007.

Purchases by state-owned or controlled national oil companies (NOC) slipped from a record high set in 2006, the analysis found. However, NOC deals still accounted for roughly $43 billion, or 29%, of total worldwide transactions. "A notable shift in this activity was the emergence of petro dollar-backed Middle East entities as the primary M&A market investors outside of their region in 2007," the authors noted.

Despite a strong overall incline in commodity prices in 2007, implied values differed dramatically from region to region in 2007. Global average proved and probable (2P) reserve pricing declined by 10% overall, and 2P pricing rose only in two study regions, Asia-Pacific and (marginally) Africa and the Middle East. In all other regions, deal pricing declined, including modestly in the United States and Canada (1P reporting basis) and more steeply outside North America.

In fact, North America represented 62% of worldwide transaction value last year, a record high in the five-year study period, and 55% more than in 2006.

"North America was the focus of three-quarters of total global deal count, slightly above its three-year and five-year averages and split evenly between the U.S. and Canada," said the study. Outside North America, M&A dollar volume in 2007 was primarily driven by the auction of the former Yukos assets in the former Soviet Union, which recorded 25% of total worldwide transaction value.

In a joint letter, Herold COO Christine Juneau and Martin Lovegrove, vice chairman of Oil and Gas for Standard Chartered Bank, pointed out that after years of favorable conditions, "the industry has been facing rough seas. Access to opportunities has continued to become more restricted and securing approval for project and deal go-aheads has lengthened. Ironically, the industry had better margins at $30 oil than at the year-end 2007 price of $96/bbl."

Juneau and Lovegrove noted that with "access to resources remaining restricted and organic reserve replacement costs on the rise, this year companies will continue to look to grow through M&A and divestitures. The asset market will remain highly competitive in the most sought-after areas with increasing competition coming now also from the sovereign wealth funds, particularly those in the Middle East, who entered the market with vigor for the first time in 2007."

Besides using mergers to achieve scale, "corporate consolidation may occur to improve the efficiencies of the industry, but this will likely only happen in any significant way if oil prices were to fall for a sustained period to below US$80/bbl."

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