North Sea asset sales healthy for now
A post-2014 shake up has revitalised the basin, but challenges remain for private equity investors looking to exit, says RBC
A UK North Sea E&P sector that is leaner and better equipped to deal with volatility cycles has emerged from the cutbacks and soul-searching triggered by the 2014 price crash, according to bank RBC.
A healthy M&A market is putting assets into the right hands, either existing players expanding their portfolios or new entrants attracted by improved regulations and the UK’s legal certainty, Martin Copeland, RBC’s head of EMEA Energy told Petroleum Economist at Aberdeen’s Offshore Europe conference.
The looming challenge is, though, how private equity (PE) investors that have backed a number of the North Sea’s recent new entrants withdraw their funds, particularly with a global equity market aversion to E&P stocks making the IPO route look particularly challenging.
Do you expect to see the trend of North Sea new entrants growing? And will we see existing players continue to re-order their portfolios and, in some cases, exit the region?
Copeland: The shock was great in 2014, but what has been really impressive is the reaction that came out of that. The Oil and Gas Authority has done an excellent job in terms of encouraging growth. It has re-organised lots of aspects and the changes feel like they will stick. There is also a more stable tax environment, and this has helped create a competitive field.
Talking about the renaissance of the North Sea and what has happened here since the 2014 crash, it is amazing to see what has been sold– even some ultra-late-life assets. The noteworthy thing is that whatever has been out there, has sold which cannot be said for other parts of the world today.
There may be doubts over the demand for more asset sales, but actually, the way we see it, the buyer food chain is still evolving. People have been warning of the death of the North Sea for decades, yet it keeps reinventing itself. Why, you might ask? Simply because investors know that here we have security, we have law, and there is a lower chance of losing everything as has happened on occasion in destinations such as West Africa. There is also a great knowledge base and debt and equity funders here in the UK, and the combination of these factors helps in getting deals done.
If there is a trend for some of the new entrants to float in the coming years, e.g. when PE investors want to exit, what will the appetite be for these firms in the European equity market?
Copeland: Obviously the standard base case for PE is to build up a company, grow it to a certain size and then either sell to another larger player or float on the public markets – hopefully having added some value in the meantime. Siccar Point, for example, has added a great deal of value to its portfolio, especially at Cambo.
The problem with that model today is that it is not obvious that all of these guys can exit through an IPO. It is almost like the public market investors are ‘on strike’ when it comes to buying E&P equities.
This is not just a UK or European problem but also in the US, the world’s biggest equity market. You hear arguments that this is a symptom of the energy transition, with investors moving away from carbon intensive businesses, but we believe it is in fact simpler than that, in many, cases the companies themselves just have not demonstrated a history of generating good returns on capital–so the allocation of investor capital away from the space is financial common sense.
The lack of public market equity appetite could presage longer-term trends towards hydrocarbons becoming the ‘new tobacco’ or could just be the investment cases themselves–the two factors have become somewhat conflated. We think that ultimately the power of financial returns will rule the day, but the investment cases that win out will be under more scrutiny than ever.
What are the challenges for these smaller operators in attracting attention in the global debt market?
Copeland: The bank market is wide open, because banks like the reserve-based lending (RBL) model. especially in the North Sea. There are a large number of active banks, so facilities in the billions of dollars can be raised relatively easily today. Banks like RBLs as they tend to offer reasonable return on capital and the structures give the banks enough levers to ensure they always have early warning of any potential issues.
The other debt source available to North Sea E&Ps is bond markets—these can be open, but also have a tendency to shut suddenly, because they tend to be driven much more by extraneous macro factors. For some of the newer players, for example [Israeli producer Delek’s North Sea subsidiary] Ithaca buying Chevron’s Central North Sea assets, they used a $1.65bn RBL, and then they tapped the US high-yield market, raising a further $500mn. The challenge is that this is about the most you can raise at reasonable cost as a first-time issuer. All North Sea issuers face comparisons against US companies of a similar size, even if many of these tend to be of lower quality than many North Sea companies.
Will players need to develop a clearly differentiated story and/or bulk up to secure significant investor interest?
Copeland: Every adviser will tell a company entering any IPO that they face a competition for capital, but for E&P companies in today’s market it feels like this competition for capital is very, very real and not all the North Sea companies out there will be able to tap the public equity markets.
This means that PE firms will need to find other ways to return capital to their investors. One way is just to hold the assets for a very long time and dividend out the cash returns over time, but this depends on the mandate of the funds, as many are limited to 10-year lifespans. The other method is to not sell to the public markets at all but to trade—a firm like Siccar Point, owned by [PE companies] Blackstone and Blue Water Energy, with high-quality assets that would fit very well in someone else’s portfolio, can definitely look at that route.
As you have mentioned, globally, the general story around listed oil and gas firms in recent years has been destruction of shareholder value? How can North Sea producers looking to list promise to buck that trend?
Copeland: What happened was that the whole industry got fat and happy at $100/bl oil, so there really was no financial discipline as there was view that the price would stay high forever. Project costs spiralled.
But the shock that the system suffered in 2014 was in many ways like a forest fire for the North Sea in that, although destructive, it has enabled renewal and regrowth. The new companies that are being built today may get some benefit from the commodity price, but they are designed to not need that price support to generate their returns.
Rather, they need to execute on the right industrial decisions—infill wells, hub strategies etc. A lot of the majors will say they have also made themselves lean—but, when you look at some of the newer entrants, they actually have a long way to go in terms of how a truly efficient operation can be run.