The price is right
The credit crisis presents cash-rich companies with a buying opportunity, writes Tom Nicholls
MERGERS and acquisitions (M&A) activity in the oil and gas sector remains robust, as well-capitalised companies take advantage of lower equity valuations to boost reserves.
In the first three quarters of 2008, 220 transactions took place globally, with a combined worth of $78bn, according to JS Herold, a research and consulting company (Herold's data include deals that are valued at $10m or more only). Although that implies a lower year-end total than in 2007 – when 330 M&A transactions, with deal value amounting to $152bn, were undertaken – it is reasonably high by historical standards (see Figure 1).
In the US, some 100 deals were done in the first nine months of the year, with total transaction value at $31.5bn. That reflects the global situation in that it implies a year-end total slightly below the 2007 level, when there were 145 deals, with a total transaction value amounting to around $50bn. But the final 2008 figure will nonetheless be reasonably healthy. It is likely to be similar to the 2006 total, around the three-year average and above the five-year average.
Chris Sheehan, director of M&A research at Herold, describes M&A market liquidity as "very steady", particularly in asset acquisitions. Acquirers tend to be companies that are able to finance purchases without recourse to debt markets, where credit has become more costly and elusive because of the global financial crisis. That well-heeled group includes national oil companies (NOCs), which account for six of 2008's 10-biggest upstream transactions (see Table 1).
The majors also remain active: the two largest deals are acquisitions by ConocoPhillips, buying 50% of Origin Energy's Australian coal-bed methane to liquefied natural gas (LNG) project for $5.848bn, and Shell, with its $5.838bn acquisition of Duvernay Oil, which produces 25,000 barrels of oil equivalent a day (boe/d) from the Western Canadian Sedimentary basin, mainly from tight-gas deposits.
Cash-rich independents are also among the buyers; the US' XTO Energy accounts for two of the top-10 deals. And, in late September, the US' Occidental Petroleum agreed to buy the 50% of Plains Exploration & Production's interests in the Permian basin of West Texas and New Mexico and Piceance basin of Colorado that it did not already own, adding 92m boe in proved reserves to its portfolio. With Plains needing to pay down debt in a soft equity market, the price indicates the extent to which market conditions favour the buyer: at $1.25bn, it was $300m lower than the $1.55bn Oxy paid in December for the first 50% of the assets.
Indeed, as a result of lower price-earnings ratios – down by as much as 60% in some cases over the last six months – M&A has become a more attractive way for international oil companies (IOCs) to expand their reserves, especially, points out Sheehan, given the shortage of opportunities for growth through the drill-bit. "To move the needle, IOCs are going to have to turn to the acquisition market, both in assets and on the corporate side," he says. For example, ConocoPhillips says the Origin deal should enable it to book reserves of 100m boe – a substantial proportion of its production (around 15% of 2007's average output of 1.88m boe/d).
Companies with assets in areas with large resource potential – such as Canada's oil sands, or US unconventional gas resources – are particularly likely to become targets, because their resource base is large enough to make an appreciable difference to the reserves of major oil companies. The addition of Duvernay, which plans to increase production to 70,000 boe/d by 2012, will result in a near doubling of Shell's North American tight-gas production.
Lower equity valuations may also lead to some consolidation among IOCs – another quick fix for sluggish reserves growth. Total and Shell are understood to be considering bidding for a 20% stake in Spain's Repsol YPF that debt-ridden Spanish construction firm Sacyr wants to sell – a purchase that both would probably have regarded as prohibitively expensive a few months ago.
But given the robustness of oil prices, which, despite falling by around a third since July, remain at historically high levels, there is probably not yet sufficient pressure on upstream margins – except, perhaps, in high-cost areas such as the oil sands – to push companies into a widespread phase of consolidation. That could change, says Sheehan, if oil prices were to drop further. "Below $80 a barrel, we would expect more corporate consolidation because of the run-up on the cost side."
Additional liquidity in the oil and gas M&A market could be generated by companies affected by problems in financial markets divesting assets to focus on their core businesses, says Andrew Smart, head of Accenture's energy and utilities strategy practice. Firms may also see joint ventures and mergers as a way of strengthening balance-sheet weaknesses, he adds. "The financial crisis is as likely to stimulate M&A activity as dampen it."
... and victims
The financial crisis has its victims too. In September, Denver-based Antero Resources, a privately owned explorer focused on unconventional gas, was forced to scale back plans to buy upstream acreage from Dominion Resources because of difficulty obtaining financing. It had planned to buy 205,000 acres in the Marcellus Shale for about $0.552bn, but ended up with 114,259 acres, costing $347m.
Meanwhile, US upstream M&A activity among master limited partnerships (MLPs) – publicly traded limited partnerships – has been severely curtailed because of difficulties raising funds in the equity and debt markets (see Figure 2). In 2007, according to Herold, MLPs were involved in almost 30 upstream acquisitions, with deal values amounting to nearly $8bn. So far in 2008, just 10 deals have been conducted, with transaction value amounting to a measly $0.5bn.
Small exploration and production (E&P) companies, such as those listed on London's Alternative Investment Market (Aim) or on the Toronto Stock Exchange, have also become less able to fund acquisitions – constrained by the high cost of capital, the shortage of credit and, in the case of explorers without producing assets, a lack of cash. Indeed, adverse financial circumstances and falling share prices have made them increasingly attractive take-over targets for larger companies, including NOCs – which are eager to buy overseas companies and assets to enhance the security of energy supply to their home markets, or to acquire upstream skills and expertise – and sovereign wealth funds.
In late September, China's Sinopec offered $1.8bn in cash for Canada-listed Tanganyika Oil, an E&P company with operations in Syria that achieved gross oil production of 16,670 barrels a day in the first half of the year. Significantly, the deal was not dependent on external financing arrangements: Sinopec funded the deal from "internal resources". The transaction, said Zhou Baixiu, head of the Sinopec division that bought Tanganyika, is part of the company's strategy to become a "diversified global resource provider". If that is unsurprising, Baixiu also claimed that Sinopec's "strong technical experience" and "local relationships" – qualities usually claimed by Western majors as advantages over NOCs – would help it extract the best out of the assets.
India's Oil and Natural Gas Corporation (ONGC), which had also been interested in Tanganyika, made a similar claim after its late-September cash purchase of Russia-focused Imperial Energy for £1.4bn ($2.5bn). RS Butola, managing director of ONGC Videsh (OVL), ONGC's overseas upstream arm, said OVL's "financial strength and technical expertise" would enhance Imperial's growth potential. And he noted an advantage that NOCs generally have over IOCs in negotiating deals: the ability to capitalise on, or help foster good relations at government level. Said Butola: "This is an important opportunity to expand on the continuing co-operation between Russia and India in the energy sector."
The other four acquisitions by NOCs in Herold's top 10 were: the $2.2bn purchase of Devon Energy's oil and gas business in Equatorial Guinea by the country's NOC, GEPetrol; StatoilHydro's $2.1bn acquisition from Anadarko of the 50% of Brazil's Peregrino oilfield that it did not already own and of a 25% interest in the US Gulf of Mexico's deep-water Kaskida discovery; Petronas' $2bn acquisition of a 40% stake in Santos' undeveloped coal-seam-gas-to-LNG project in Australia; and KazMunaiGaz' $1.8bn acquisition of an additional 8.48% stake in Kazakhstan's Kashagan oilfield from the Agip KCO consortium.
IOCs have also been busily thumbing through the Aim bargain-basement catalogue. In September, Italy's Eni said it was acquiring First Calgary Petroleums (FCP), an exploration company listed in Toronto as well as in London, with assets in Algeria. For the cash price of $0.923bn, Eni says it will boost its reserves by 190m boe and acquire output of 30,000 boe/d from 2012.
Meanwhile, in June, XTO Energy said it was acquiring Hunt Petroleum for $4.2bn in cash and shares, adding proved reserves – mostly in Texas and Louisiana – of 1.052 trillion cubic feet (cf) of natural gas equivalent and production of 197m cf/d of gas, 8,500 b/d of oil and 2,300 b/d of natural gas liquids. The deal also includes 15,000 net acres of leasehold in the Bakken Shale region of North Dakota. In May, XTO had announced the acquisition of producing properties and undeveloped acreage from privately held Headington Oil for $1.85bn in cash and shares. The purchase includes 352,000 net acres of Bakken Shale leasehold in Montana and North Dakota, and, says XTO, proved reserves of 68m boe and 10,000 boe/d of production.