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The dating game

With oil prices falling, the Statoil-Hydro merger could be the first of many M&A deals in oil and gas, writes James Gavin

THE ranks of national oil companies (NOCs) has a new and powerful addition, following the merger of the Norwegian energy companies Statoil and Hydro in December. The $29bn paid by Statoil for Hydro was the stand-out transaction of 2006 in the oil and gas sector – and the third biggest of the decade, creating the world's largest offshore operator in the process (see box).

Coinciding with a dip in oil prices, the merger triggered speculation about prospects for more mergers in the oil and gas sector. Lower oil prices are seen as one of the main drivers behind a revival of mergers and acquisitions (M&A) activity in the industry. Many large oil companies have stayed away from the asset market in the past three years, put off by exorbitant prices.

BP's chief executive officer (CEO), John Browne, predicted last year that a fall in the price of oil would set off a wave of mergers. ExxonMobil's upstream chief, Stuart McGill, said the firm was keen to make acquisitions, but only when prices were sufficiently low.

Similarly, Deutsche Bank analyst Paul Sankey told a conference call in January: "What we'll eventually find is increased activity that really wasn't possible at the very high prices last year. When the price goes down, some of the really big guns will start to roll out. With the strength of corporate balance sheets, there's plenty of potential for M&A activity – that's the first thing we're looking for."

If average oil prices continue to fall from their 2005-2006 peaks, in the $60-70 a barrel range, and industry costs continue to rise, this will place substantial additional pressure on margins and stock prices. In early January 2007, US benchmark crude WTI sank below $54/b. The case for consolidation may soon start to look unanswerable.

That case is given added impetus by the state-owned oil firms' burgeoning muscle. NOCs have announced their presence in the global M&A market with some landmark deals in the past couple of years. China National Petroleum Corporation took over Toronto-listed PetroKazakhstan for $4.2bn in late 2005 and China National Offshore Oil Corporation (CNOOC) launched an audacious – if unsuccessful – $18bn bid for the US' Unocal. State-owned firms from Russia and India are also targeting corporate assets. Analysts say the growing competition from NOCs will put the CEOs at the integrated oil companies under greater pressure to snap up assets.

The climate for broaching such deals looks increasingly convivial. Total global M&A, according to Dealogic, amounted to $3.87 trillion last year. M&A in the oil gas sector has been steadily rising in the past couple of years, growing to $159bn in 2005 from $67bn in 2004, according to a report from John S Herold and Harrison Lovegrove.

A compelling reason to merge

According to Herold, rising upstream costs are a compelling reason for companies to join forces. With extreme competition for materials and services driving cost increases, says Herold, some will encounter difficulties to the degree that being bought will look better to shareholders than continuation. "Take the Canadian tar sands," says Herold analyst John McIvor. "There are 20 projects under way, costs have gone crazy and that's an incentive to merge." In addition, with labour in short supply, acquisitions are a quick way for companies to boost their workforce.

Many companies have resisted buying oil and gas assets in recent years on the grounds that they tend to be overvalued. However, there are signs that the market is accepting that the cyclical baseline for prices has shifted upwards. Chevron, for example, was willing to pay a premium of around $5bn on the Unocal stock price, even before rumours emerged that CNOOC was in the race to buy the company in 2005.

Peter Hitchens, an analyst at Teather & Greenwood, a brokerage, says companies' reluctance to buy assets stemmed from different valuation models adopted by much of the oil industry and the stock market. Equity markets were basing valuations on oil at $60/b and oil companies were devising investment plans on the basis of an extremely conservative price projection of about $30/b. "As the two converge, that will signal the start of consolidation in the sector," says Hitchens.

The mega-mergers in the late 1990s were mainly motivated by the need to cut costs as oil prices fell to long-term lows. By contrast, recent acquisitions seem motivated by long-term strategic aims: the aim of the merger of Statoil and Hydro, for example, appears to be to improve access to overseas assets.

But size is not everything: with NOCs able to buy in expertise and technology, the need for large, supermajor balance sheets may not always prove so compelling. However, with a combined market capitalisation approaching $100bn, the new company's greater financial clout will improve its chances of success in competitive bid rounds.

Additionally, in Norway there is extensive duplication in the firms' licence interests. Consolidating these holdings will free up specialist staff for new ventures overseas, easing the present recruitment problem. Consolidation should make for better use of drilling rigs and it is claimed that decision-making will be speeded up. When it comes to bidding for the big opportunities, such as Russia's giant Shtokman gasfield, the two Norwegians will no longer be competing against each other, but in co-operation.
Similarly, ConocoPhillips' acquisition of Burlington Resources, completed in March 2006, was primarily motivated by Burlington's attractive North American gas assets, which complemented and strengthened ConocoPhillips' US gas portfolio.

Bankers and lawyers are rubbing their hands in anticipation of a bigger M&A deal flow, although they acknowledge there is not an abundance of obvious candidates. Analysts suggest the brightest opportunities for the majors will be in picking up small exploration and production (E&P) firms that, having gambled on oil prices of $50/b, may be caught out by a fall in commodity prices.

Potential targets

Two potential candidates for purchase are the UK's BG Group, holding a number of robust growth projects across the Middle East and Africa, and Woodside Petroleum, Australia's largest E&P company, which has interests in Africa, North America and the Asia-Pacific region. CNOOC is one of a number of companies to have expressed interest in acquiring the latter, while several large companies would be interested in buying BG's highly regarded gas-weighted portfolio.

However, a bid for either seems unlikely in the immediate future. BG is still regarded as expensive. Woodside is protected by the Australian government, which blocked an attempt by Shell to buy the company in 2001.

Predators are also likely to be more inclined to buy companies with regionally focused assets, rather than those with a geographically diversified spread of interests. This helped underscore the interest in the UK's Premier Oil, which was the subject of a bid approach in late 2006 from Middle Eastern and Indian firms. In the event, Premier – which has clusters of producing assets in the UK, Indonesia and Pakistan, and exploration licences in south Asia and west Africa – rejected what it deemed a hostile take-over bid.

However, investors in the Mideast Gulf, looking to recycle large volumes of liquidity, are likely to attempt further acquisitions in the oil and gas sector. In the United Arab Emirates, for example, special investment vehicles are being set up to develop international oil and gas portfolios.

The larger US independents, such as Anadarko Petroleum, are viewed as unlikely take-over candidates, given their abundance of onshore US acreage – mature oil assets that are of limited interest to the majors.

Canada's oil sands offer another possibility for acquisitions, given the large number of new projects under way and the willingness of operators to be bought up at the right price. "We are likely to see more M&A activity," says Randy Ollenberger of BMO Nesbitt Burns, a Canadian broker. "Shell's bid for a majority interest in Shell Canada was primarily motivated by its oil-sands interests."

Norway: Statoil gains Hydro, at last

THE MERGER between Statoil and the oil and gas operations of Hydro, agreed by the firms' boards in December, is being presented as a tidying-up move – in contrast to the mergers between majors of the late-1990s, cost-cutting is claimed not to be the main objective, writes Martin Quinlan. The two companies, both substantially owned by the Norwegian state, are both looking overseas for new development prospects now that the country's big fields have been found and they see no need to compete.

While both were thinking they were in the running for the operatorship of the Shtokman field, in the Russian part of the Barents Sea, long-running talks about a merger were put on ice – but Gazprom's decision in October to carry out the development without foreign partners made further delay pointless. Hydro's forecast in the first week of December that its 2010 hydrocarbons production would be 7% lower than expected because of "industry capacity constraints" improved Statoil's bargaining position.

The merged company – to have a new name, yet to be chosen – will be approximately 62.5% state-owned. According to a ministry statement, "the state's goal is to be a long-term owner and it intends to gradually increase its ownership to 67%". The present Statoil is 70.9% state-owned, while Hydro is 43.8% state-owned.

The deal will be all-paper, with Statoil shareholders receiving one share in the new company for each existing share they own. Hydro shareholders will receive 0.8622 of a share in the new company for each existing share, and will continue as owners of Hydro – which will be an aluminium producer. The merged entity will be owned 67.3% by Statoil shareholders and 32.7% by Hydro shareholders. Subject to approvals by shareholders and regulatory authorities, the merger should be completed in the third quarter.
The new company is claimed to be the world's 12th-largest oil and gas firm, and the largest offshore operator. Oil and natural gas production in 2007 are forecast to amount to 1.9m barrels of oil equivalent a day (boe/d) and proved oil and gas reserves are put at 6.3bn boe.

Statoil and Hydro have both apparently seen the peak of their oil production, although both have growth to come in gas. Statoil's highest oil output was about 0.74m b/d in 2003, with the flow declining to about 0.66m b/d in 2005, while Hydro's high of 417,000 b/d in 2004 dipped to 398,000 b/d in 2005. Including gas, Statoil produced 1.169m boe/d in 2005 while Hydro produced 0.563m boe/d in that year.

Both firms are heavily weighted towards Norway in their production operations, but both have made considerable efforts in recent years to gain exposure to frontier provinces overseas. Statoil's largest source of oil outside its home country is Angola and it also has production in Azerbaijan, the US Gulf of Mexico (GoM) and Venezuela, among other countries. Hydro has interests in the GoM, acquired through its purchase of Spinnaker in 2005, Libya, Angola and elsewhere.


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