Oil firms ready to pick up the infrastructure divestment pace
Pipelines, storage facilities and processing plants could replace non-advantaged production as prime candidates
Oil and gas producing firms create the most value by exploring for, developing and producing hydrocarbons. Internal rates of return (IRRs) far in excess of 20pc are the norm for successful upstream projects.
Indeed, one of the challenges of the pivot to renewables and the lower-carbon future has been that these sort of investments do not generate anywhere near the same sort of returns—leading firms such as BP, Total and Norway’s Equinor to pioneer models where their spend is almost seed money to attract other investors and leverage their initial outlay to a higher IRR.
So, it is not surprising that infrastructure assets in the portfolios of producers, both IOCs and NOCs, are now coming under more scrutiny in these capital-constrained times. These parts of the portfolio offer limited returns in a majority of cases. In the developed world, many come under regulatory oversight, with either mandated, index-linked tariffs or, where tariffs are negotiated, some guidelines on reasonableness and recourse to arbitration to stop owners charging exorbitant rates.
In certain parts of the developing world, infrastructure assets are subject to much less regulatory scrutiny. Owners can hoard the capacity or, if making it available, extract significant value for doing so. But, even there, it is the capacity, not the physical asset itself, that is creating the value.
49pc – Proportion sold of Adnoc pipeline network
And sellers can and will secure access to the capacity as part of the deal to sell. Indeed, their guaranteed custom for the capacity can boost the selling price they will get from a vendor.
Abu Dhabi’s Adnoc has just completed a deal to sell 49pc of its domestic pipeline network to a consortium of private equity and pension funds. And, in Australia, both Shell and Chevron have hung ‘for sale’ signs around physical LNG processing plants.
“I do not think these will be one-off deals,” says Stuart Joyner, an analyst at London-based research firm Redburn. “But, at the same time, it is not necessarily the start of a new trend—majors have been selling infrastructure assets for the last 5-10 years.”
One reason for their enthusiasm is clear: there is a market for these assets. “Pension funds and private equity can use leverage and a lower cost of capital to extract value from them,” says Joyner. “They are looking for long-term investment income and these types of assets offer them.”
“The appetite from infrastructure-focused capital is there,” agrees Jon Fuller, global head of advisory at consultancy Xodus. “And, while most macroeconomic forecasters predict we are going to be in a low or even negative interest rate environment for the foreseeable future, it may not always be there.”
“Oil and gas companies, particularly the large ones, will come under more and more pressure to fulfil their promises on investing in renewables and in the low-to-zero carbon future” Fuller, Xodus
That buyer willingness is key, particularly given that majors have been focusing a lot of their divestment plans of late on unwanted production assets they can sell to smaller, nimbler operators who can extract greater value through a more focused approach. These assets will be far harder to sell in the current environment, with issues around finding interested parties and then agreeing a price acceptable to the buyer but worth the seller’s time.
As such, Joyner expects producers’ infrastructure sales to get even more popular. “There are still a lot of these types of assets held by majors,” he notes. “We did a report a few years ago on how much pipeline infrastructure BP had in its portfolio. And, since then, it has sold its Alaskan pipes.
BP has just completed a major non-infrastructure sale, flogging a petrochemical business that had fallen a long way behind its peers in size to UK petchems specialist Ineos for $5bn. The major trumpeted that the deal meant it had achieved its divestment targets ahead of schedule.
But Joyner does not believe that BP will now simply sit back on its portfolio, including its infrastructure component. “BP has a different shaped balance sheet issue to its peers; its gearing is much higher. So its divestment target had more riding on it. I do not think its sales are necessarily over,” he predicts.
To some extent, the cash generated from selling infrastructure can and will be used to bolster balance sheets battered by the Covid-driven collapse in prices. But there is also an aspect that money brought in can be spent elsewhere.
“Firms will not put cash generated directly into other capex—it will not be ‘we got $5bn in, we will put that $5bn into something else’. But it is a zero-sum game, the cash goes into a pot and the size of the overall pot determines what you can do. So it might subsidise other capex,” says Joyner.
The analyst does not see a direct link between selling off infrastructure assets and investing in the new busines lines that firms committed to ambitious future net-zero targets must launch. “That spending is largely ringfenced and it is not yet particularly large, typically around 10pc of the capex budget.”
Fuller is less convinced. “When you need to make investments in renewables as part of new net zero commitments, you are going to have to keep monetising assets to fund that increasing capex,” he predicts. “Oil and gas companies, particularly the large ones, will come under more and more pressure to fulfil their promises on investing in renewables and in the low-to-zero carbon future.
“I do not think these will be one-off deals… but, at the same time, it is not necessarily the start of a new trend” Joyner, Redburn
“In the past, investors were more patient about giving firms time to fulfil their promises. But they are now demanding full-speed ahead, particularly among the more activist of the energy transition investor base. I am thinking of people like Mark Lewis [global head of sustainability research] at BNP Paribas [Asset Management]. Firms are not going to have the ability to ignore the capex costs they are going to have to bear.”
Middle Eastern NOC sellers, such Adnoc, have, in Fuller’s view, an additional dynamic. By selling minority stakes in infrastructure, they can both signify they are open to foreign direct investment into their economies and also use the capital to diversify national economies that remain heavily dependent on oil and gas.
There are obstacles to completing more infrastructure deals, some logistical and some commercial around the future value of assets. Some of the Covid-related restrictions on movement can easily be overcome by relatively simple technology, such as signing documents remotely.
But it is more difficult to run the usual diligence about the integrity of physical assets that you would need to perform before closure, warns Fuller, suggesting deals may need to involve condition precedent or interim agreements before the in-person checks that lenders require are done. Even here, innovative solutions are being explored, such as hi-res cameras on drones to examine critical pieces of infrastructure.
On the commercial side, a bigger risk is security of demand for assets. But Fuller feels that this could be overstated. “The useful life of assets, if properly maintained, is pretty long. Looking at the supply/demand dynamics for oil and gas, you should expect to be okay for 20-30 years of life. If you are looking at a 50-year lifespan, then maybe you would need to think about repurposing, such as switching gas pipelines to carry hydrogen.”
While infrastructure assets are largely shielded from price dynamics, sustained low demand and prices could obviously affect supply and hence facility usage. But most significant pipeline infrastructure, for example, is anchored on at least one large producing asset, notes Fuller. And that asset is usually relatively resilient in a low-price environment as operational efficiencies and technical innovations can be applied that make a significant impact to lowering opex.
Smaller fields are more vulnerable, but they are rarely the basis for large-scale infrastructure. Exceptions could be in the US, where production is significantly more price dependent, or in a disproportionately late-life basin. “If an investor is looking at a 15-year time cycle, if they are worried at all about volume curtailment, it is likely years 11-15, not the first 10 years,” says Fuller. “And there are also potential future production volumes to be considered. Even so, in many deals, some portion of the overall value will be discounted.”