Mind the divestment gap
Oil and gas majors are setting increasingly ambitious divestment targets, despite volatile market conditions and questions over the size of the buyer pool
Cash from divestment forms a major part of oil majors' projected revenue streams , as well as more focused Opex spending, going into the 2020s. Yet despite an uptick in activity—and, arguably, bargain-basement prices—firms appear to be struggling to offload certain "non-core" assets
In its annual report for 2018, BP noted that total divestment proceeds reached $2.9bn, against a target of $3bn for the year; but going forward it expects this to ramp up to more than $10bn over the next two years.
The phrase "supported by divestment proceeds" is repeated several times in the report as a basis for meeting objectives such as reduced debt, echoing the sentiment in other majors' annual reports.
BP notes that the higher target reflects its plans to shift the company's core focus towards US shale assets it acquired from UK-Australian producer BHP in July 2018. Shell and the other majors' targets are equally ambitious.
A report last year from Shell noted the completion of a $30bn divestment programme for 2016-18-on which it embarked after its deal for UK gas producer BG in 2015-including deals such as a $2.4bn sale of upstream assets in Norway in two separate transactions, and the exit from its New Zealand gas assets for $578mn. But Shell also expects to continue divestments at an average rate of more than $5bn a year until at least 2020.
And ExxonMobil, Chevron and other North American firms, which had not been big sellers of assets, are now starting to see it as a key part of reshaping their portfolios, says Luke Parker, VP corporate analysis at Wood Mackenzie, a consultancy. This is unlike European majors that have used divestment to reduce debt and improve gearing for years.
Chevron, for example, recently announced an increased $20bn divestment target over the next two years to help fund its ultimately failed effort to acquire US independent Anadarko. Chevron's asset sales reached $2bn last year, and it will likely revert to its previous goal of $5-10bn, after US independent Occidental succeeded in its competing offer to acquire Anadarko.
Eni saw gains from divestments fall to just €454mn ($507mn) in 2018 from €3.2bn a year earlier. The sales of 10pc and 30pc interests in the Zohr asset in Egypt made in 2017 to BP and Russia's Rosneft for a total of €433mn boosted the previous year's figure.
UK as divestment hub?
As a centre of major deal activity in Europe, the UK's North Sea provides a useful snapshot of the divestment landscape.
Notable transactions last year included Norway's Equinor buying Chevron's interest in Rosebank, west of Shetland-financial details were not disclosed. And Shell, previously a seller of ageing assets such as its January 2017 sale of UK continental shelf (UKCS) assets to independent Chrysaor-which is backed by private equity (PE) cash-illustrated an ongoing appetite for new assets when it acquired a stake in another PE-backed producer Siccar Point Energy's Cambo project.
However, a firm buyer has yet to emerge for Chevron's planned sale of all its UK central North Sea assets, including the Alba, Alder, Captain and Erskine fields, as well as the Britannia, Elgin/Franklin and Jade non-operated projects. The proposed sale was announced under Chevron's pre-Anadarko divestment targets.
Despite the sizeable targets ahead, analysts expect divestment sales to remain healthy, even for the mature assets on the UKCS. "There is no shortage of buyers in the UK, companies have not had many problems unloading their non-core assets," Ross Dornan, market intelligence manager at industry lobby group Oil and Gas UK, tells Petroleum Economist.
"UK upstream had been quite sheltered from PE investment, but they have become much more prominent in the supply chain. We have seen this new wave arrive-a new type of company with different priorities and strategies."
The North Sea divestment plans of majors and other exiting players have thus far benefited from a new range of buyers, for example, Chrysaor's April announcement of its acquisition of US independent ConocoPhillips' UK oil and gas business for $2.675bn. But the deal also reflected the major geographic shift that currently dominates the M&A landscape and which ultimately may prove a challenge if too many firms end up on one side of it-namely, the move by majors other than Total and by US independents towards a main focus on US shale.
"All of the larger divestment sales and strategies in the UK-Marathon, ConocoPhillips and Chevron-relate to retreating to North American shale. It is a highly capital-intensive area that is drawing these companies in," says Dornan.
"Supplementing core assets with acquisitions and divesting non-core assets will continue. Recent prominent deals reflect producers' desire to buy as well as build, while US shale growth will attract interest as major producers seek to consolidate exposure in the Permian," says Andy Brogan, global oil & gas transactions advisory services leader at financial services firm EY. "We will see more in the way of deal value over volume, as producers look to build further optionality into portfolios to stimulate long-term growth and potential business transformation."
The capacity, infrastructure and strategic location of the US shale industry mean majors are likely to seek to continue to use asset disposal programmes to narrow their geographic focus and portfolio plans towards the US. This also gives firms a chance to offload assets seen as less desirable due to environmental and political complications, as long as buyers can be found.
"The majors have low-margin assets that are nonetheless resilient, and this means they can sell off the assets that do not suit their aims; for example, Shell selling its entire stake in Canadian Natural Resources for $3.3bn," says.
Several majors have put up for sale their Canadian oil sands assets over the past few years as pipeline bottlenecks, high costs and low local prices discourage investment. But finding buyers has not been easy.
Oil and gas producers have attempted to offload producing assets pumping more than 180,000bl/d oe in Western Canada, as well as undeveloped land, according to data from M&A analysis firm Evaluate Energy. However, the past year has seen no buyers emerge, and only one small deal has been agreed between two relative minnows: Shawcor's $308mn acquisition of ZCL Composites.
The heavy discount on Western Canadian Select and regional natural gas prices in the latter half of last year may have also depressed the sales activity in the region.
In terms of deal activity in the US, Drillinginfo, an energy analytics company, reported in April that US oil and gas M&A deal values had plunged to a record 10-year low in the first quarter of 2019.
The firm says a primary contributing factor is likely Wall Street's pressure to deliver on free cash flow, as well as the "weak equity and debt markets available to fund deals". Unlike in the UK, private equity, which has in recent cycles stepped in as an opportunistic buyer to take advantage of pullbacks in the US, last year largely sat on the sidelines.
The impact of the 2014 oil price crash, when initially companies struggled to sell assets after Brent's price fell from $115/b to $51, was a major factor in discouraging would-be sellers. "Volatility and moments of weakness can see sales grind to a halt," says Wood Mackenzie's Parker.
But market downturns can also eventually spur more M&A activity as acquiring companies look to take advantage of lower prices. In the oil and gas sector during 2015, financial buyers spent more than $25bn investing in acquisitions, joint ventures, and funding private E&P companies, according to figures from bank HSBC.
Parker says it is significant that the level of global activity and spend was relatively resilient over the course of the 2014-16 downturn. "Majors have reached even some of the much more onerous disposal targets over recent years-people doubted that Shell could meet its $30bn target, but it did. There is plenty of liquidity out there."
Although the cyclical nature of the oil and gas industry will likely leave the asset disposal landscape vulnerable to oil price fluctuations, advances in technology and the willingness to explore niche upstream methods are also keeping divestment fluid.
"As assets and fields start to move towards the end of their productive lives, firms can create better value from them," says OGUK's Dornan. "Certain assets are just more valuable in the hands of another buyer," adds Parker. "Assets that would have struggled to compete in the hands of a major can do well with another firm."
He says this is why "huge swathes" of LNG, deepwater and other non-core tail-end portfolio are being handed over to smaller, often PE-backed, firms that have built a management strategy revolving around certain kinds of exploration. And, typically, when an asset changes operatorship, an average field life extension of nearly five years can be achieved.
Outside the UK, in South America the Brazilian oil and gas giant Petrobras has successfully executed three sale and purchase agreements worth $10.3bn in the past two years alone. The transactions include the sale of Petrobras' 90pc stake in gas transmission firm Transportadora Associada de Gás (TAG) to France's Engie and the Canadian pension fund Caisse de Dépôt et Placement du Québec.
Petrobras has also sold a 50pc working interest in Tartaruga Verde field (BM-C-36 Concession) and Module III of the Espadarte field, both located in the deep waters of Campos Basin, offshore Brazil, to Malaysia's Petronas. And it has offloaded all of its stakes in 34 ageing onshore production fields in Rio Grande do Norte to Potiguar E&P, a subsidiary of Brazilian operator PetroReconcavo.
On a post-results conference call with analysts in February, CEO Roberto Castello Branco said the firm sees a "bold" plan for sales of non-core assets as being the key to reducing debt. The firm will pursue "a more aggressive divestment programme and getting out of assets where we are not a natural owner", Castello Branco said.
Petrobras plans to reduce its ratio of net debt to Ebitda to 1.5 or even to 1, with the help of divestments, he added. The ratio at the close of the fourth quarter was 2.34.
Following an oil price rally that saw Brent flirt with $75/bl in May, Equinor agreed last month to spend $965mn in cash to buy Shell's 22.45pc stake in the deepwater Caesar Tonga oilfield in the US Gulf of Mexico, using its pre-emption rights to block would-be buyer Delek of Israel. Delek has also been linked with North Sea asset acquisitions, including the Chevron portfolio, making it one of the few international independent E&P firms that appears to have a global expansion of its footprint within its strategy. More of these types of buyer might give greater confidence that majors can hit their divestment targets.
Elsewhere, there has been less activity, and, as oil prices retreated into late 2018, there were no major acquisitions by Chinese NOCs. Beijing is likely attempting to prioritise domestic expansion of oil and gas exploration to supplement its hefty imports, estimated by S&P at 70pc for oil and 40pc for gas last year.
S&P Global Ratings said in April that deal levels in Africa and western Asia had also proved disappointing in some cases-"most national and private Asian oil producers are increasing focus on their home markets in their search of production scale and reserves".
In terms of majors' regional sales, Shell is continuing its divestment plan in Asia and is looking to offload its 35pc stake in Abadi, an Indonesian LNG project at a pic tag of up to $1bn, says Parul Chopra of Rystad Energy, a Norway-based energy research firm.
Total annual energy deal values in Asia have ranged between $5.4bn and $8.7bn in the past four years, according to Wood Mackenzie data.
Not all sunshine
Earlier this year, OGUK noted that continued volatility in oil prices, along with increased optimisation and cash flow within exploration and production firms, could also "dampen" overall deal activity in the North Sea.
"There will be continued consolidation within the market this year with companies right-sizing their portfolios…We think this is positive for the basin because having the right investment opportunities in the right ownership will be critical to delivering production from these assets," says Dornan. A 40pc drop in oil price at the end of last year also served to "shake" investors, he adds.
That price plunge, for instance, was given by many analysts for the collapse of an attempt by US petrochemicals firm Ineos to buy North Sea oil fields from US independent ConocoPhillips earlier this year-the same assets that Chrysaor agreed to buy in May as the price rallied.
But, while prices stay buoyant in early summer 2019, major new entrants are also looking at the assets on offer through divestment programmes.
Saudi Aramco has turned acquisitive, exploring natural gas partnerships and assets in North America, the Russian Arctic and Africa as it aims to nearly double its total gas production to 23bn ft³/d over the next 10 years.
Earlier this year, Aramco said it would move beyond its traditional business developing Saudi Arabia's vast oil reserves and expand into international exploration, which could see it compete with the majors but also as a potential asset buyer. In May, Aramco signed a heads of agreement with US firm Sempra to take a 25pc stake in, and 5mn t/yr of offtake from, its planned Port Arthur LNG export terminal in Texas.
Despite a potential widening of the buyer field, ultimately, activity could remain constrained due to continued caution over the timing of the energy transition and ongoing international trade tensions. Hopes for a return of confidence last year were rapidly quashed with the plunge in Brent at year-end, and price uncertainty will only continue to hurt divestment.
However, the valuation gap between buyers and sellers may also shrink as advances in technology create potential for well-capitalised companies and private equity-backed firms to take advantage of majors continuing to upgrade and prune their portfolios. It looks like being a bumpy ride, rather than the smoother progress the analyst community might prefer, but it is too early yet to write off the majors' vast combined divestment target is unachievable within existing timeframes.