Time for financial discipline
The pattern of consolidation and restructuring among oil companies during the past year looks set to continue
As 2017 ends, it is on track to go into the history books as a year of moderate recovery for the world oil industry: Opec output is broadly stable; the global inventory overhang is broadly shrinking; and oil prices are up nearly 13% from their January level. The combination triggered a broad recovery in oil investment activity across all sectors as companies consolidated both their upstream and downstream positions, many repeating a popular mantra: value over volume.
According to Deloitte Touche Tohmatsu's Oil and Gas Mergers and Acquisitions Report-Mid-Year, 2017, global energy M&A activity was up 57% in the first half of this year, to $137bn. The US Energy Information Administration reported that during the second quarter capital expenditure at the 108 publicly traded companies it follows was up 4% from a year earlier, while debt was reduced. The EIA noted that equity returns turned positive during the first half of the year after 18 months in the red, although they lagged well behind those in other sectors.
These improvements reflected three themes which dominated recovery from the 2015-16 oil-price crash. Upstream, oil companies concentrated on consolidation of portfolios. The US and Canada, in particular, saw progressive narrowing of companies' focus as firms concentrated on areas in which they held competitive advantages and high-grade acreage. Meanwhile, major oil companies, led by Shell, selectively restructured their portfolios to reduce debt and streamline strategy. Finally, a series of midstream and downstream acquisitions by national oil companies and leading oil traders allowed them to broaden and integrate their systems. All three themes can be expected to continue into 2018. Transactions in the US Permian and Marcellus shale basin and Canada accounted for the majority of upstream acquisitions' value in the first half of the year.
Upstream, US activity was the main 2017 attraction, as companies continued to reduce costs, increase free cash flow and consolidate their positions, particularly in the prolific Permian, as oil output continued its recovery from early-2016 lows. Deloitte noted 44 upstream transactions in the Permian during H1 2017, which accounted for a record $20bn of the total. The leading transaction by value was ExxonMobil's $5.6bn acquisition of Bopco acreage to expand its Permian position. Away from the Permian, the first half-year saw $10bn of transactions in the northeastern Marcellus shale, mostly accounted for by EQT's $8.2bn acquisition of Rice Energy, in a natural gas-focussed transaction.
After such big-ticket acquisitions, the market appeared to catch its breath: PWC's US Oil and Gas Insights third quarter 2017 notes that transaction activity slowed, with a 6% increase in their number, but a 58% decrease in the total value of transactions, to a quarterly total of $23.6bn. The third quarter saw buyers moving away from the Permian to smaller transactions in other areas, such as the Bakken. "The predominant strategy driving deal volumes this quarter was portfolio rationalisation through non-transformational deals," PWC said.
In Canada, most upstream activity was the consequence of large oil companies' decisions to withdraw from the long-cycle, high-cost, high-emissions Canadian oil sands plays. Their aim was to reduce debt and concentrate on lower-cost, shorter-cycle production opportunities. The $26bn in oil sands transactions reported by Deloitte during the first half of the year accounted for nearly 30% of total, global M&As in the upstream during that period. Nearly all of the value reflected Shell's and ConocoPhillips' retreat from the oil sands sectors. Both companies looked to reduce corporate debt and, in Shell's case, further restructure the company portfolio in the direction of natural gas, following its 2016 acquisition of gas specialist BG Group.
Outside North America, upstream development concentrated on relatively low-risk projects, including transactions in the mature UK North Sea. This is now largely the preserve of smaller independent oil companies, focussed on maximising the recovery of remaining reserves. "Risk is not back into Arctic or extreme stuff," said a London-based banker.
Bankers say such substantially de-risked developments include East African gas. Eni launched its Coral liquefied natural gas project offshore Mozambique and ExxonMobil announced it would acquire a 25% interest in Eni's offshore Mozambique Area 4 block. In West Africa, BP acquired an interest and operatorship in Kosmos Energy's gas discoveries offshore Mauritania and Senegal. BP also acquired a 10% interest in the fast-track, Eni-operated Zohr gasfield offshore Egypt.
13% - Oil price rise since January
Additional opportunity for development and finance exists across the Atlantic, as Mexico and Brazil further open up their upstream sectors. The development by ExxonMobil, Hess and Cnooc of their discovery offshore Guyana is likely to focus attention on that region. Leading oil companies are migrating towards expanding activities in known basins with relatively short development timescales, and away from mega-projects. Total's commitment to develop part of Iran's South Pars gas and condensate field is seen as an outlier. Shell's planned withdrawal from Iraq's giant Majnoon oilfield in 2018 is an example of a leading international oil company recalibrating its exposure to such opportunities.
Midstream and downstream activity this year has seen Saudi Aramco continue its strategy of downstream integration by agreeing to spend $7bn to buy into Petronas' Rapid refining and petrochemicals project, as well as to acquire significant oil storage capacity in northwest Europe through an agreement with Russian trader Gunvor. In further market integration, trader Vitol acquired control of Austrian OMV's Turkish Petrol Ofisi chain, and trader Glencore, with a South African partner, acquired Chevron's Southern African oil refining and distribution assets. The oil service sector also saw significant transactions as GE agreed to acquire Baker Hughes and Wood Group bought Amec Foster.
Oil markets are increasingly confident that producers will stick to their self-imposed output limitations, and that inventory levels will continue to reduce. So 2017's trends could well continue into 2018, even without the headline value boost that Saudi Aramco's expected market debut might bring. The shadow of the 2015-16 price crash may keep the industry concentrated on value rather than volume for the foreseeable future.
This article is part of a report series on Oil and gas finance. Next article is: Oil companies dig deep