A bumper year of mergers and acquisitions activity has been dominated by the actions of state-owned companies and by politics. Derek Brower reports
IT ANGERED politicians from Brussels to Washington, but Gazprom's Sakhalin Island raid has been voted by readers of Petroleum Economist the energy sector's best deal of 2006 (see box). Almost 44% of voters in our annual mergers and acquisitions (M&A) poll consider Gazprom's acquisition of a controlling stake in Sakhalin Energy from Royal Dutch Shell and its Japanese partners to be the deal that will bring "the greatest strategic and financial benefit to the acquirer in the next five years".
In distant second place, with around 20% of the vote, came the proposed merger of Norway's two largest energy firms, Statoil and Hydro. Shell's purchase of the remaining shares in Shell Canada came third.
For anyone whose livelihood depends on the M&A activity of oil and gas companies, last year was a good one. According to John S Herold, a consultancy, the total value of the transactions completed in the sector in 2006 rose for the third year in a row to $160bn – the highest total since the bonanza year of 1998.
Petroleum Economist's poll highlights many of the themes that dominated M&A activity in the energy sector during the last 12 months. The increasingly important role of state-controlled energy companies and their political masters, emboldened in the last couple of years by high oil revenues, is the main one. There is now, says John S Herold, "intense competition [for assets] between independents, majors and NOCs".
The majors remain apparently unwilling or unable to compete with Chinese and Indian firms for the acreage that is available, leaving those cash-rich and energy-hungry consumer NOCs pushing their own acquisitive agenda. "Geopolitical forces are having a dual impact," notes PricewaterhouseCoopers (PwC), an accounting and consulting firm, in a recent report.
"Countries such as Venezuela and Russia have moved to limit or even reduce opportunities for overseas companies in their oil and gas fields. Conflict and political uncertainty has had an impact in the Middle East. This has led companies to look for deals in OECD and other Western markets. At the same time, NOCs in countries such as Russia, India and China have stepped up their own acquisition activity as they seek to move outside their home bases to expand their markets and secure supply."
Given that NOCs control almost 90% of the world's reserves, these trends are unlikely to change soon. Canada, with its wealth in the oil sands, is an exception: its oil sector remains attractive, given the low royalty payments demanded, and open (see p22). The relatively low level of M&A activity – in dollar terms, if not in the number of transactions – in the Alberta oil patch is therefore surprising and suggests large deals may soon start to occur.
Chinese and Indian companies continue to covet the oil sands. Digesting a company such as Suncor or Syncrude, the two biggest oil-sands operators, might not be easy for a Chinese or Indian NOC, given some of the cultural resistance to them in Alberta's political world. But they and other big players in the oil sands will look increasingly appetising in Beijing or Mumbai.
In the last 12 months, however, the two biggest oil and gas deals in Petroleum Economist's poll were all about state consolidation – in contrast to the late 1990s, when corporate consolidation, motivated by cost cutting, was the main driver of M&A activity. Then, a period of low oil prices meant buying reserves cheaply and slashing costs by reducing the scale of merged operations was the most effective way to keep shareholders happy. Now, few in the sector are talking seriously about what companies euphemistically refer to as "synergies". A sustained increase in oil prices has shifted the balance of power and capital away from the Western majors and into the hands of the resource-rich states; this process is being consolidated, it appears, by M&A activity.
The two biggest transactions – Gazprom's take over of control on Sakhalin and Statoil's merger with Hydro – involved state-controlled firms. These factors, as well as the increasing involvement of private equity in the market, helped push M&A activity in oil and gas in 2006 to $291bn, compared with $250bn in 2005, says PwC. That included a 61% year-on-year increase in medium-sized deal values, with half of those deals accounted for by the oil services sector (which PwC includes in its total, unlike John S Herold).
Gazprom's desire to be involved in Sakhalin Energy is easy to understand from the Russian company's point of view. Its executives have frequently stated the company's ambition to become one of the world's leading exporters of liquefied natural gas (LNG). But having last year apparently abandoned plans to develop LNG from the Shtokman field in the Barents Sea, the absence of any genuine projects belied the ambition.
The $7.45bn Sakhalin deal changes that: it will give Gazprom valuable exposure to the LNG business. Additionally, the Russian firm will make a solid return on the investment once Sakhalin Energy starts producing later this year. With 9.6m tonnes a year (t/y) of LNG exports from two trains, Sakhalin Energy will account for around 8% of the world's LNG demand. It already has three sales agreements in place with Japanese companies, for 3.1m t/y.
Gazprom's involvement also reflects the extent to which the balance of power has shifted away from the commercial to the public sector. Shell's contract to develop Sakhalin with its partners was based on a production-sharing agreement (PSA) the company signed with Russia in the 1990s, when oil prices were low, Russia's economy was on its knees and foreign investment was badly needed. The generous terms of PSA contracts from the private investors' point of view reflect those circumstances.
By 2005, however, sustained high oil prices had made the PSA terms look like an egregious mistake from a former era. The government's discontent with the arrangement intensified last autumn, when Shell said the cost of the project had doubled to around $20bn (some insiders say the true figure could be even higher); this delayed the date when Russia would start to make money from its own reserves because, under PSA terms, investors are entitled to recoup costs before paying out revenues to the state.
Sakhalin Energy was subsequently threatened with the removal of its operating licence after Russia's environmental watchdog accused the company of environmental violations. The charges were at best excessive and at worst spurious, but facilitated Gazprom's entry into the project.
Despite this, Russia remains a land of opportunity, says Shell. Peter de Wit, executive vice-president of Royal Dutch Shell's global gas and power business, claimed at April's LNG 15 conference in Barcelona that having Gazprom as a partner – despite the controversial genesis of that partnership – puts Shell in a good position to become involved in other Russian projects. The company has signed an agreement with Russia that will allow it to explore upstream activities around Sakhalin. And de Wit says the potential of the Sakhalin-2 LNG project goes "way beyond three trains".
Norwegian sense ...
If the Sakhalin deal shows the determination of a state to strengthen its already formidable national energy champion, so does Statoil's proposed tie-up with Hydro. But the Norwegian merger is also reminiscent of the mergers of the late 1990s. Norway has discovered the logic of "synergy", the neologism that summed up the prevailing orthodoxy of the last M&A phase. PwC calls it "defensive scaling-up".
The merger will, for the Norwegian state, clear up several anomalies. One of them was that two firms in which the state held large stakes (in Statoil, 70.9%; in Hydro, 43.8%) have for some time competed for the same contracts. For example, before Gazprom decided to develop the Shtokman field alone, Statoil and Hydro were two of the firms vying for a stake in the Barents Sea gasfield. Gazprom has recently indicated it may again seek a joint venture to execute the project. Combined, the Norwegian companies would be an attractive partner – largely because of the technical challenges involved in developing the icy offshore field.
The deal will also tidy up the Norwegian energy sector. It is a mature province and producing more oil and gas in the country will need large amounts of technology and capital. Additionally, turning two Norwegian champions into one will give Norway full control over the sector's future. Perhaps more important, personnel and capital that was being duplicated in the upstream can now be directed towards foreign prospects.
StatoilHydro – or whichever name is eventually chosen – is likely to be one of the most successful NOCs in the pursuit of foreign upstream equity and reserves. The greatest beneficiary of the merger will be the Norwegian state. The government says it will increase its stake in the merged firm from 62.5% to 67% "over time".
... and generous Canadian rents
Another tidy-up operation was judged by Petroleum Economist's readers to be the third best oil and gas deal of the last 12 months in terms of strategy. That was Shell's consolidation of control of Shell Canada, a deal that cost the parent company over $7bn and gave it total ownership of the Alberta-based firm. Previously, it owned 78%. When news of Shell's attempts to gain total ownership of the company broke, some analysts suggested Shell was tightening up slack in its organisation ahead of a potential merger, possibly with BP. That would be the biggest industrial merger in history. Bankers and lawyers were licking their lips in anticipation.
But the reasons for the Shell Canada deal now look more prosaic: a cash purchase of oil-sands reserves with the potential for other savings – probably by reducing the number of employees in Calgary and centralising their activities in London or The Hague. But the deal is illustrative of other trends too. Would Shell have spent $7bn buying the remaining shares in a company it already controls if other, easier ways to find oil and gas somewhere else in the world presented themselves? Probably not. In the new environment, the majors are finding it better to stick to what they already have.
Shell Canada was a safe investment for Shell – even if it took a good deal of wrangling before the minority shareholders agreed to sell. With the scale of the oil sands and Ottawa's and Edmonton's apparent unwillingness to follow other resource-rich nations in ramping up the rents on its oil and gas developments, Canada remains the exception in a world of diminishing quality acreage available to the majors.
That is largely the result of the other main theme underlying the M&A activity of the last 12 months: the power of consumer NOCs. High oil prices have made resource owners more confident and less reliant on financial and technological help from outside. At the same time, NOCs in the fastest-growing consumer countries, especially China and India, are becoming more dominant.
The sustained strength of the oil price is having little effect on the appetite of these firms for assets in producing countries. China's CNOOC did not balk at the $5bn price tag for its involvement in a planned LNG development at Iran's South Pars gasfield, however expensive and speculative the deal looks. As Uwa Igiehon, managing director of energy finance at RBC Capital Markets, says: "What the Chinese firms need more than anything is advice, not financing."
Nor are the terms that are being demanded by many of the producers in exchange for access to reserves – capital-intensive investments in refineries, railways and other infrastructure – deterring the consumer NOCs (PE 4/07 p23). This kind of deal-making tends to be decided at the top level of government and sometimes involves other sweeteners, including weapons (for example to Sudan) and lines of cheap credit (for example to Angola).
Western firms that are losing out to NOCs tend to caricature their state-backed rivals as rapacious firms using corrupt means and paying scant attention to human rights, the environment and local communities. But many Africa analysts challenge this view, saying the new model of engagement between Africa and Asian firms could be a better one for the host countries than that which previously emerged through the activities of Western majors (PE 4/07 p22).
Compare the share-price performance of state-controlled firms with fully listed majors over the past 10 years, says Keith Myers, an energy analyst at Chatham House, and the majors are losing out there too.
The next wave
That should give investors pause for thought when, as many analysts predict, another wave of M&A activity, probably led by the NOCs, begins. According to the predictions, NOCs may even attempt to buy a major. CNOOC's $18.5bn bid for Unocal in 2005 met political resistance in the US. But it is probably only a matter of time before another similar attempt is made.
Western companies discovered the money to be made in outsourcing back-office functions to Asia. How soon until Chinese and Indian companies outsource their oil-finding businesses to backwaters in Finsbury Circus and Shell Tower?