Logistics no barrier to deal making
The current M&A market environment is challenging, but deals can still get done
Price crashes in the oil market often lead to M&A activity. Indeed, four of the five majors in the form we know them today were forged in the aftermath of the late 90s slump—Exxon and Mobil and Chevron and Texaco joined forces in the US, while Total, Fina and Elf did the same in Europe. BP crossed the Atlantic to hoover up first Arco, then Amoco.
And the last large-scale acquisition by a major—Shell’s swoop for UK-headquartered BG— also took place post the 2014 fall in prices. It stands to reason that the current environment should also offer opportunities for deal making. But will the unprecedented physical constraints imposed as a result of the global Covid-19 pandemic get in the way of M&A processes?
“There is still the potential for deals to happen,” says Anthony Patten, co-head of oil and gas at law firm Shearman & Sterling. “There are willing buyers and sellers, and we are seeing some pre-crisis divestment processes continuing, in particular in Asia.”
But there are clearly challenges posed by the current widespread global lockdown. “If you look at oil and gas, it is probably the most cross-border, cross-cultural industry there is,” says Patten. “Assets are typically held among numerous partners in joint ventures; many companies have international portfolios; there are language and cultural considerations which make remote deal making quite challenging.”
The bespoke nature of most deals in the sector is also an issue. “In our experience, during more complicated transactions, when sticky issues come up the real progress is made through senior people having face-to-face discussions,” he cautions. But, encouragingly, the industry is adapting to its new circumstances. “While those conversations are obviously more difficult at the moment, they have proven possible, and indeed increasingly popular, using the technology with which we are all becoming very familiar,” says Patten.
“We have seen a reasonable amount of activity
this quarter, even in the depths of oil price and pandemic despair” Rachwal, GaffneyCline
Fellow panellist Chris Rachwal, head of M&A at consultancy GaffneyCline, agrees with a theme of cautious optimism. “We have seen a reasonable amount of activity this quarter, even in the depths of oil price and pandemic despair,” he says.
One potential bright spot is the midstream, Rachwal suggests. While, in the longer-term, midstream assets may be impacted by structural energy transition changes and reductions in demand, in the short-term the sector is relatively immune to oil price gyrations.
Another relatively oil price-immune asset class is gas production sold on fixed-price contracts, often to a state-backed buyer with a market monopoly. These were “ugly ducklings in the past,” says Rachwal, given their lack of upside in a higher price environment, “but now they are stars”. Any M&A involving them will likely proceed with gusto and probably close in the next three to six months.” One favourable trend for getting deals done is that the M&A market was already on an upswing. “We came into 2020 on the back of a steady increase in 2018 and 2019,” says Greg Zdun, head of oil & gas, power and utilities, Asia-Pacific at bank JP Morgan.
“In 2019, there were over 200 deals amounting to some c.$160bn, slightly up on 2018, and we were encouraged by what we saw at the start of 2020—at that time it looked like it was going to be an even better year,” Zdun says.
Based on his experience of deals in the 2015-16 period, where there were “more conversations around structured solutions to bridge valuation gaps between buyers and sellers”, he expects this year and next to also feature “discussions around the levers that help transactions complete in an environment of high price volatility”.
Among those levers, Zdun singles out structures such as deferred payments, commodity price earn-outs, contingent payments, and royalties. He also notes that, while the focus may be on distressed sellers, would-be buyers may also face challenges around their own balance sheets, which may mean vendor loans feature in some future M&A activity.
Another key factor in getting deals done will be a reduction in volatility in the oil price. “As greater stability returns to the market, we expect to see an increase in the volume of potential transactions,” says Zdun. “Part of that may be a release of pent-up demand where the plan had been to bring the asset to market in the first half of the year.”
Shearman & Sterling had also been anticipating a busy first half of 2020 in upstream M&A, particularly around the majors’ ongoing divestment programmes of non-core assets. It also supported Middle Eastern producers looking to invest in refinery and petrochemicals assets in Asia to provide a demand hedge for their supply.
“The reasons for doing those deals are still there,” says Patten. “The geopolitical trend of Middle Eastern investment in Asia’s largest demand markets will also not go away. It may not be the Middle East NOCs’ immediate priority, but the battle for Asian customers will continue. So, we are hopeful that activity will pick up quite quickly once the market stabilises.”
“Middle Eastern investment in Asia’s largest demand markets
will also not go away” Patten, Shearman & Sterling
Despite the headwinds, only one of the five EMEA transactions that GaffneyCline was working on in March has been “deferred until more stable conditions” says Rachwal. Three, if not all four, may go forward to final bids, but Rachwal acknowledges that price will be a very challenging point in the current volatile environment.
And the firm has received inquiries on another four to five possible deals, he says, adding up to a “market that is as active as it was at the end of 2019, although yet-to-start processes are typically running 1-2 months late as people take stock”.
The US market has a slightly more pressured picture, cautions Patten, although one still conducive to deal making. His colleagues in the US have, he says, “been very focused on distressed transactions”.
“Quite a lot of focus in the US upstream is already on shale players in difficulties, and the different sorts of processes whereby assets might be acquired from those players, such as bankruptcy or similar procedures,” he continues.
Oil and gas assets may also benefit—particularly at current prices—from looking more attractive as an asset class than they have been of late, at least in the short-term. “In a global market where everyone is trying to rebuild their economies and recover from very negative second, and possibly third, quarters of 2020, the opportunity to invest in future supply of reliable, and relatively inexpensive, energy may appeal,” says Rachwal. In contrast, some more “exotic” clean energy alternatives are going to be considerably “less vital for economic recovery” in the next 12-18 months.
“In the medium to long-term, obviously the theme of energy transition will continue to be important for the industry. But I agree with Chris [Rachwal] —in the short term, incremental capital may not necessarily be deployed on alternative energy solutions at the same pace that was expected. The pressure on capital allocation, may offer a reprieve of sorts for more conventional assets,” agrees Zdun.