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Bring on the deals

Conditions are right for a surge in M&A activity in 2017, despite lingering uncertainty over valuations

Mergers and acquisitions activity is primed to take off in 2017. As 2016 came towards a close, initiated deals were at record levels, with majors setting ambitious divestment targets, operators streamlining their businesses, services firms restructuring and some national oil companies in the Middle East and Africa taking steps towards privatisation.

The mood as 2016 came to a close marked a radical shift from the first half of the year, when the M&A market remained volatile and cautious, at one point setting a new record for inactivity. That partly occurred as companies adapted to the structural change taking place in oil and gas markets - the shift from an era in which notions of resource scarcity drove capital-investment decisions to one characterised by perceptions of oil and gas abundance.

In the final two quarters of 2016, though, confidence in the outlook for the oil price began to recover, encouraging a North America-driven uptick in M&A activity. It should continue in 2017. The Permian basin continued to dominate activity, accounting for around 40% of US deal value. For 2016 as a whole, the transaction value involving the acquisition of American acreage was more than double that in 2015, as companies consolidated positions or moved into unconventional oil and gas for the first time.

Quality will still be a watchword for deals in 2017. In 2016, the majors showed an appetite for acquiring high-quality liquefied natural gas and Brazilian assets. They have also used the downturn to increase their ownership of premium undeveloped fields in which they already participate. Europe didn't see the same kind of recovery. North Sea deals remained subdued due to the cost of UK assets and decommissioning liabilities associated with late-life projects.

Midstream activity in America was relatively robust in 2016, with Enbridge's $46bn acquisition of Spectra Energy leading the way, creating North America's largest infrastructure company. With interest-rate rises a possibility in 2017, the midstream M&A market could be due for a further shake-up. The sector is exposed to a risk of excess capacity because of subdued demand, and consolidation may be needed to cut costs and maintain returns to investors.

The fundamentals driving downstream transactions will remain robust. Upstream-focused companies could divest non-core downstream operations to improve returns and focus investment in core regions. But that is not a certainty: substantially lower upstream returns in recent months have increased the attractions of operating an integrated business. Predominantly upstream companies may be reluctant to part with downstream assets that are generating substantial operating cash flows.

Consolidation in the oilfield-services sector continued in 2016 with the merger between FMC and Technip. This kept the overall value of M&A deals comparable to that in 2015. But the number of deals declined as overcapacity cancelled out the benefits of synergies arising from M&A.

Despite conditions that appear conducive to a recovery in M&A activity, buyers and sellers are still often too far apart on asset valuations to make deals a certainty. Most sellers are divesting to repair balance sheets and manage capital positions. But buyers have capital or debt at their disposal and are spoiled for choice. The impact of Opec's decision to restore some control over its production may affect market dynamics too. Immediately after Donald Trump's election, it wasn't clear what impact he'd have on US M&A - but the initial signs were not negative. Yet this is an industry - in M&A as in other realms of the business - keenly focused on cost and cash flow. Every business decision comes down to the simple question: does it make economic sense? If the answer in 2017 is yes, deals will get done.

This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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