Oil Sector Primed For Major Merger And Acquisition Activity
Oil and gas merger and acquisition (M&A) activity has ground to a halt in recent months due to extreme volatility in commodity markets. But don’t expect that to continue, especially in the U.S. exploration and production (E&P) sector, where valuations look attractive for buyers in the maturing shale business.
The price of global benchmark Brent crude plunged from $85 a barrel in October to below $50 in late December. The volatility spooked investors and made it impossible for buyers and sellers to agree on the fair value of assets like oil fields and drilling rigs, helping explain the paralysis in M&A markets recently.
The sharp plunge in prices also took a hefty toll on energy share prices, and E&P valuations are now trading at 10-year lows relative to the broader stock market. Combine cheap valuations with strong balance sheets, slowing production growth, and oil prices that appear to be stabilizing, and it creates a more fertile environment for wheeling and dealing.
All one needs to do is look at M&A activity before the price rout took hold in November. Despite M&A activity falling into sleep mode in late 2018, last year still was the most active for deals in the United States upstream since the price collapse of 2014, with a total deal value estimated at $84 billion.
The third quarter, right before prices went over the cliff, saw a record-setting $32 billion in transactions, fueled by a number of large billion dollar-plus corporate deals. In five days in late October alone, corporate consolidation saw a bona fide frenzy with Denbury buying Penn Virginia for $1.7 billion, Chesapeake bidding $4 billion for WildHorse, and EnCana acquiring Newfield for $4.2 billion.
The week also featured action in the oil services sector which has struggled to recover from the price crash five years ago. Denver-based ENSERVCO, a provider of specialized well-site services to onshore producers, acquired privately held Adler Hot Oil Service to enhance its position in the Bakken. These sort of deals carry strategic and cost benefits, and are integral to reducing overcapacity in the oil services sector.
The foundation for robust M&A activity in the oil and gas industry is re-establishing itself and could result in even more aggressive dealings this year. Oil markets are starting to react positively to the implementation of the new OPEC-led supply cuts, with Brent crude rising above $60 a barrel and U.S. benchmark WTI moving above $50 in the early days of the new year.
Meanwhile, after experiencing rollercoaster price volatility recently, U.S. producers are planning conservative capital budgets for 2019, primarily based on a WTI price of $50 a barrel. Over time this should result in slowing oil and gas production growth rates. The United States will remain the most significant driver in non-OPEC production, but achieving annual growth rates of over 1.5 million barrels a day as U.S. producers did in 2018 is an unrealistic expectation.
At the same time, industry balance sheets are much healthier than in the immediate aftermath of the 2014 price collapse. That means there are more companies capable of making acquisitions, including major oil companies like Exxon Mobil, Chevron, BP and Shell that are now significant contributors to the shale boom after building up their positions in recent years.
The landscape of shale producers remains fragmented and with the sector continuing to focus on capital discipline and financial returns – particularly after the recent price scare – consolidation is a proven way to achieve efficiencies and synergies.
There is further scope for corporate consolidation among producers, but the recent price plunge and low evaluations have opened the door for private equity to return to the M&A. Private equity took a backseat to corporate transactions last year, but the current cocktail of appealing market conditions could prompt a resurgence, including deals to take public companies private.
New York hedge fund Elliot Management has already demonstrated this opportunistic approach by offering over $2 billion for Permian producer QEP Resources. Elliot has in the past taken positions in oil and gas companies and pressed them to make strategic changes to boost stock value. But the QEP bid is the first time it has sought to buy an oil company fully. Highly leveraged producers could face a similar fate in the current market, as could companies whose investors are fed up with underperforming management teams.
Price volatility will remain a concern for dealmakers, but conditions are far too ripe for M&A to stay dormant much longer in the oil and gas industry.