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Report: Tight Gas Plays Propel U.S. M&A Activity

Tight natural gas plays were at the top of the list for acquisition-minded U.S. buyers in 2007, with merger and acquisition (M&A) total transaction value reaching $49.2 billion in 145 significant deals -- both record highs -- according to a report prepared by John S. Herold Inc. and Harrison Lovegrove & Co. Ltd.

The "2008 Global Upstream M&A Review" found that the United States accounted for 32% of the $154 billion in total global upstream transaction value, which was about 5% higher than the five-year average. North America represented 62% of worldwide transaction values last year, a record high in the five-year study period, and a substantial increase of more than 55% from 2006. The global portion of the study was issued earlier this month (see NGI, March 17). Herold and Lovegrove dissected the North American portion on Wednesday.

The record number of asset deals propelled U.S. deal count and transaction values to new heights for the second consecutive year, said Chris Sheehan, Herold's director of M&A research, who answered questions about the report during a conference call. Most of the deals worldwide last year were gas-related, but some huge oil-related transactions in the former Soviet Union involving Yukos "distorted" the survey somewhat, he said.

"There was a widely higher percentage of gas deals in 2007, and again, oilsands moved the needle in Canada," said Sheehan. "The United States was best for gas, and in Canada, excluding oilsands, there also was a higher percentage of gas deals." The survey estimated that about 71% of the U.S. transactions in 2007 were for proved gas reserves, a five-year high, compared with around 60% in 2006. "Gas deals still predominate in the U.S., and excluding oilsands, about 59% of Canada's deals last year were in gas."

Transactions last year to acquire U.S. proved gas reserves rose 55% from 2006 to more than 11 Tcf, with a continued focus on emerging tight gas plays, Sheehan noted. Transacted proved reserve volumes in 2007 increased more than 35% over 2006, almost reaching the five-year record set in 2004 during consolidation of Rocky Mountain producers. Dominion Resources' decision to sell its exploration and production portfolio, through a series of deals, led all U.S. M&A transactions (see NGI, Aug., 20, 2007).

Despite the overall transaction values hitting a record, U.S. deal pricing slumped slightly last year, dampened by volatile gas prices and purchases of longer-lived reserves, with average and median proved reserve implied values hovering around $13.75/boe. Meanwhile, strong crude prices drove implied proved reserve values for oil-weighted transactions more than $4.00/boe higher to more than $17.00/boe, a significant premium to gas-focused deals ($12.78/boe), and a reversal of the relationship in 2006.

Many companies were still digesting the considerable acquisitions made between 2004 and 2006 when strong commodity prices lifted share prices of potential targets, so the overall corporate deal count was cut in half, the survey noted.

Only two U.S. corporate transactions worth more than $1 billion were completed during the year, including the Dominion Resources transaction. Strong blended commodity prices and prospective high sector returns also attracted nontraditional buyers, including private equity firms, to the U.S. upstream M&A market, but only one firm based outside North America was among the top 10 buyers of U.S assets. More master limited partnership asset buyers -- primarily through July 2007 before a credit squeeze emerged -- helped augment U.S. total acquisition spending.

Transactions involving assets in two or more regions accounted for more than 35% of total U.S. transactions. The biggest transactions involved the Gulf of Mexico, where proved reserve implied values topped $22.00/boe, and oil accounted for half of the proved reserves transacted.

Transaction value and deal count also reached record highs in the Midcontinent region, but proved reserve deal pricing remained the second lowest of any U.S. region because of the increasing weighting toward long-lived tight gas plays, said the authors. Transaction values also reached a five-year high along the Gulf Coast, while proved reserve deal pricing remained the second highest at $15.17/boe. However, transaction values in the Rocky Mountains dropped by more than 50% last year because "the level of deal activity has been closely tied to movements in gas differentials," noted the study.

Canadian deal count and transaction value also soared to record highs in 2007, while transacted proved reserve volumes nearly doubled because of a five-fold increase in oilsands reserves. Proved reserve implied value in Canada declined slightly to US$28.61/boe, but remained the highest in the world -- and a significant premium to U.S. pricing. Oilsands deals accounted for 40%, and royalty trust consolidation accounted for 30% of Canada's transaction value last year.

"Our outlook on asset deals is that they will dominate over corporate deals," said Sheehan. It's difficult for businesses to buy entire businesses, he said, because of many factors, including shareholders, integration and pricing. "Historically, that is typical for a company to aggressively search for assets out there...The main reason for the dip in corporate deal count and value in 2007 was the very strong commodity prices and the share prices of potential targets, which were very high last year. A company is very reluctant to take on those companies. But the corporate outlook for consolidation is there...Generally there is a tendency for conditions to be rip for corporate consolidation, particularly if there is a downturn in oil prices and that point of impact on share prices, which makes a potential target for a stronger company.

"International oil companies, NOCs [national oil companies] and others have the balance sheets, they are fiscally strong, and they are looking for new deals. You hear that to grow reserves, you have to do it through drilling or through mergers and acquisitions, and companies are continually challenged. When finding and development costs are high, you go into the M&A market...Companies turn toward corporate acquisitions, but there are regional competitors that may want to combine for a cost savings basis. Companies also need to grow to compete with their larger peers on a global basis. With commodity prices at this level, we're not seeing a whole lot of activity, but we do expect to see more corporate acquisitions on the horizon."

Through 1Q2008, few deals have been announced, but compared with 1Q2006 and 1Q2007, the level of activity is about the same, Sheehan noted. For the full year, about $88 billion worth of corporate and asset M&A deals announced in 2007.

"Combine those two [Dominion Resources and Yukos sales] and that's about 40% of the $88 billion in transactions last year. It's difficult to see a that type of number exceeded...but it's always difficult to say whether you are going to exceed a previous year," he said.

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