Richard A. Martin, Jr., Senior Director, Merrill Corporation | August 01, 2017
After the June 2014 oil price collapse, the Oil & Gas industry experienced a wave of reactive actions including cost cutting, reduction of capital expenditure, massive reductions in headcount and the shelving or outright cancelling of major projects.
Given the recent oil price volatility, and Merrill’s own observations of increased M&A activity in the sector, I wanted to know more and to understand what reactions the industry is having (and will have) to the current oil price environment. The result was a highly engaging panel discussion entitled “Executing Effective M&A: Opportunities in Oil & Gas”. Over the course of an hour, our experts discussed a number of topics including the oil & gas changing environment, fundraising and sourcing opportunity. Listen to the whole conversation on Opportunities in Oil & Gas.
A Shifting Environment
At the beginning of our discussion, a majority (44%) of our audience indicated the opinion that continued price volatility would have a negative impact on both the number and value of deals – so it is fair to say there is some negativity due to the uncertainty in the air.
Clearly the intervening years since the 2014 collapse and today have been difficult in the face of weak demand and low prices. Planning for the future, making strategic decisions and executing on them has been very challenging. That said, the panel suggested the industry overall has gone through a massive deleveraging process, and many companies have cleaned up their over-capitalized balance sheets, in relation to the price of oil, and are now ready to be recapitalized. As one of our panelists put it: “the pain has already been felt.
There has been, let’s say, a marginal recovery in oil price. There is the expectation that prices will remain in the $40 - $50 range, taking many years before moving back toward previous price highs.
Some suggest the on-going price volatility, with prices trading 10x daily consumption, makes this a trader’s market. There are various interpretations of this, but generally it means one of two things:
1) A high multiple could indicate a high degree of liquidity that helps lower the physical market costs faced by companies
2) A high multiple could indicate an excessive amount of activity conducted by traders, speculators, hedge funds and the like
Regardless of how you view it, companies need to ensure their business models are ready to manage – and benefit from -- a volatile and changing environment.
Portfolio evaluation is far more than simply using divestment to generate cash, although that can be a part of the strategy. It is also an opportunity to radically restructure the business based on forecasts of future conditions and to ensure the projects a company is working on match their capabilities.
When asked about the key considerations when pursuing an opportunity, the top three reasons our audience gave were:
- Gaining a competitive advantage and improving market share (39%)
- Cutting costs and improving margins (22%)
- Increasing overall production (13%).
To accomplish these types of goals, new business models and forms of strategic partnerships will emerge. Effective portfolio evaluation will take on a critical level of importance to answer key questions such as:
- Do I have the right business model in place?
- How can my company reduce cost and increase efficiency to develop or acquire new capabilities and technologies?
- Where do I find the funds to accomplish goals?
Traditionally, the three general stages of the oil & gas lifecycle – exploration and appraisal, development and production and portfolio expansion – have had their own distinct capitalization mechanisms.
In particular, there has been a scarcity of IPO financings over the past several years, along with tighter corporate credit conditions introduced by banks responding to new regulation. While credit conditions have improved and regulations are easing, to ensure that adequate and efficient funding is available to finance new projects, the industry will have to consider new and more creative approaches and sources of capital.
Moreover, changes are occurring to the traditional funding sources. Investors who usually concentrated in early phases such as discovery are now considering later stages like testing, drilling or extraction, which were traditionally funded by initial public offerings or banks.
For many companies, particularly upstream, M&A represents a potentially critical part of evolving or generating capital. At Merrill, we have recently observed a greater than 30% increase in Oil & Gas related projects this year (our data precedes deal announcements by approximately six to nine months).
Interestingly, 68% of our webinar audience felt that the impact of changing regulations, such as the repeal of the SEC disclosure rule, would have a positive effect on M&A activity in Oil & Gas.
Forming or partnering with special acquisition vehicles to pursue general opportunities may become more popular in general across the industry, and given the shifts in the energy sector, it should hardly be left out.
I believe that PE players’ ability to provide long-term, patient sources of capital could prove a boon given any short-term fluctuations in prices and the economics of natural gas production as oil price volatility remains in question.
For example, the shale market in the U.S. will remain intensely competitive. Central Oklahoma’s emerging plays only further complicate the mix.
A colleague of mine, John Shipman, has recently written an article titled “PE Firms Aim at Oil Patch with Pent-Up Dry Powder”, that I think illustrates this point.
Cycles will likely be short, so if PE fund managers can double down on their longer-term perspectives and modify their strategies accordingly, especially with regard to cost savings from technological advances, they could well continue to benefit in the long run.
Hedging & The Growth Opportunity Going Forward
Another element of our discussion centered around the point at which production levels justify hedging and the strategies for those companies daunted at the prospect. It is clear that effectively managing hedges is possible but does require a certain level of experience and sophistication. Most companies want to have their team’s focus on their day jobs, often outsourcing the development of strategies to third parties.
Once the funding gap has been bridged, the question arises about how to find opportunity. While each of our panelists noted that they are seeing an increase in projects, often finding the right opportunity is the challenge. Typically, the assets are considered too small to get the attention of an advisor, and organizations often lack the bandwidth. At the same time, while the seller has the expertise, they don’t have the time to deal with these types of projects.
There has been a rise in development of online communities with a growing universe of participants, were deals and dealmakers can more easily gain access to each other. The best of these online portals provide:
- Broad industry presence and access to new markets and down market transactions
- Deep knowledge of the pool of potential buyers,
- Packaging suggestions to present assets in a very consistent format,
- Bidding process facilitation and,
- Potential reduction in overall transaction costs
As an example, I invite you to have a look at Merrill’s deal sourcing portal partner, Dealgate.
Overall, we have a positive outlook for opportunities in the Oil & Gas sector – and we are not alone. Seventy percent of our webinar audience walked away with a slightly or much more positive outlook on future activity in the industry than they had at the beginning of the discussion
As an industry advocate of best M&A practice, backed by Merrill’s experience on over tens of thousands of deals over the past 50 years, I plan to continue to explore interesting topics and areas of discussion that, hopefully, will change your perspective on M&A deal making.
- Richard Martin, The M&A Guy