Hurdles slow US energy deal-making
Market turmoil is making it difficult for buyers and sellers to come together
When oil prices started to crumple last year and signs of distress in the shale sector arrived in thickets, many saw a wave of mergers and acquisitions looming on the horizon. Private equity raised tens of billions of dollars to spend in the shale patch. Oil majors primed themselves to pick off the choice acreage they had missed in the early stages of shale’s rise.
But across North America the biggest sound made by M&A in the shale sector has been a resounding fizzle. Only around $12bn in shale deals were done in 2015, the lowest number in six years. Early 2016 shows that things haven’t perked up yet this year, either.
The volatile and low oil price has been a major hurdle. On one side off the table, bargain-hunters, firms expecting to scoop up companies and assets on the cheap. On the other have been sellers convinced the low oil price is temporary, so the fair value of their assets is well above discounted levels that rely on the flat and strip oil prices.
Call it something like false-bottom syndrome, but firms now want a sustained price recovery backed by tighter market fundamentals before they pull the trigger
Frustration and fruitless negotiations have characterised things. This has been plain behind closed boardroom doors, but spilled into the open last November when Apache spurned an opportunistic takeover offer from Anadarko Petroleum. The sides were far apart on their valuations of Apache, which outright rejected the relatively small premium Anadarko had offered over Apache’s depressed share price. The misstep wasn’t good for either company, but was particularly damaging to Anadarko. The company’s share price has fallen nearly 40% since the aborted takeover bid. Apache’s share price has recovered to pre-offer levels. Both companies are now seen as possible takeover targets.
A matter of muscle
Oil-price falls in recent months have sent some potential buyers scurrying. Call it something like false-bottom syndrome, but firms now want a sustained price recovery backed by tighter market fundamentals before they pull the trigger. Neither Brent in the $30s nor brimming inventories offer much assurance for nervous buyers.
For even the strongest drillers, meanwhile, the priority has been simply to cope, not to buy. Mustering some financial strength is the order of the day. Credit downgrades have hit nearly all producers, which also crimps their ability to raise debt to buy rivals. In that case, even persistently low US federal interest rates aren’t enough to coax companies out of their acquisition lethargy.
Then there’s the debt problem. Weaker drillers owe so much that their debt burdens now act as a firewall against potential buyers. Many debt deals include clauses that require all debt be paid when a company is taken over, Occidental Petroleum’s Steve Chazen pointed out recently. That can immediately destroy the logic of a deal and wipe out the potential savings of merging operations. “It will be a tough environment for M&A, I know the investment bankers won’t like that, but I think it’s going to be a tough market,” Chazen says.
Until now, hard-pressed sellers have had other options, rather than selling up. A steady flow of relatively cheap capital from banks and bond markets has kept insolvency at bay, allowing firms to think they can wait out the depression. More recently, companies have been able to rustle up billions of dollars in new equity raisings – an unpopular move with existing shareholders but one of the few fundraising options left for most drillers. Even this option is only available to the upper echelon of shale companies.
But as the shale patch’s financial deterioration gathers pace and bankruptcies mount, things should come to a head later this year. “We’ve seen some attempts, but the balance sheets and the price deck is keeping assets from being divested,” says Scott Sheffield, chief executive of Pioneer Natural Resources. “Once the oil price gets up to $45 a barrel or $50/b, then you’ll start to see assets being sold. You need to get away from this $25-30 to start seeing consolidation.”
When deal-making does start to pick up, cash-rich private equity firms and oil majors can be expected to lead the revival. Dozens of private-equity funds have raised tens of billions of dollars over the past 16 months to spend on US energy. That capital is getting restless. Some of the cash is already starting to come into the sector. Texas-based Luxe Energy, for instance, was set up recently with $0.5bn in funds from private-equity firm NGP Energy Capital, and just did its first deal in the Permian Basin. Denham Capital-backed Lola Energy is another example. The company is using a $250m injection from Denham to start buying properties in the Marcellus and Utica shale gas plays.
At least one oil major seems to be gearing up to deal. ExxonMobil sold $12bn in bonds on 1 March, its largest-ever bond sale. Some of the proceeds could be used to buy shale fields – the company bought 48,000 acres in the Permian Basin last year – or to take over a rival. If that’s the case, ExxonMobil certainly won’t be paying the kind of premium it needed to in 2009, when it three a whopping $41bn to buy XTO.