How the energy transition is driving upstream consolidation

Upstream M&A is back with a bang. There’s nothing quite like buoyant commodity prices to embolden oil and gas producers to get back to deal-making. Are we witnessing the start of another cyclical boom in asset and corporate transactions? Or will it be different this time as the energy transition casts its shadow over the sector? Greig Aitken, Research Director, identifies five main themes unfolding.

First, the sheer strength of the rebound underway in M&A activity. All the lights turned from red to green in 2021. The deal count averaged 26 a month in Q4, the highest for three years and a far cry from the sorry hiatus of five during the worst of the crisis in May 2020. Deal spend for 2021 totalled US$138 billion, up 57% on the prior year, and the highest since 2014.

Liquidity and depth made a welcome return to the market. The six transactions above US$5 billion was one fewer than 2020, but there were eighteen in the US$1 billion to US$5 billion range compared with just two in 2020.

Second, deal-making has gone global again, helped by the availability of capital. In the early stages of recovery, North America was the hotbed of activity. The existential threat posed by low oil prices sparked a slew of equity-funded deals. These were both defensive and opportunistic, including three big ones – Chevron’s acquisition of Noble Energy, ConocoPhillips/Concho and Cenovus/Husky.

The sector’s financial strength improved through 2021, and a cash component began to feature in corporate deals. Capital markets warmed up, with investors more receptive to companies doing M&A deals than loosening up on tight capital discipline to chase organic growth and risk outspending cash flow.

International takeovers suddenly were doable. There were zero corporate deals over US$5 billion outside North America from May 2020 up to the end of June 2021. Since then, the big stuff is all outside – Santos/Oil Search, Woodside/BHP Petroleum and AkerBP/Lundin Energy.

Third, the energy transition is emerging as a dominant driver, manifesting in different ways. The bigger pure upstream players are chasing scale (targeting mini-major-scale production of around 1 million boe/d in North America, and over 0.25 million boe/d in Europe) and strengthening core positions to reduce costs and build resilience. ConocoPhillips/Concho and Chevron/Noble in the Permian; AkerBP/Lundin in Norway all fit this template.

The bigger IOCs’ strategy is to decarbonise, diversify and divest. They want to sell higher cost, high carbon-intensive, low-margin upstream assets, as well as geographically peripheral ones, to concentrate portfolios around their ‘advantaged’ assets.

It’s a buyers’ market for those with the appetite and access to finance. The implied long-term Brent price for all deals in the last six months of 2021 was just US$50/bbl, well below the US$76/bbl Brent spot average for the period. Private equity, among others, has continued to take advantage, scooping up unwanted assets to harvest cash flow.

Fourth, what we’re witnessing is the tip of the iceberg of what’s coming for sector consolidation. The upstream industry today is highly fragmented – there are over 2,300 companies producing less than 15,000 boe/d; and 300-plus producing more than 60,000 boe/d.

We predicted that the energy transition will lead to massive restructuring and consolidation in the coming decades as the sector goes ex-growth. It’s just happening earlier than we thought. The Majors are already morphing into New Energy. More companies will exit the sector completely or wind down operations.

There will be fewer, bigger E&P companies, falling into three broad business models sustainable in a decarbonising world:

• New Big Oil: aggregators of the larger independents
• Adapted E&Ps: still sizeable but focused on cash-generative advantaged assets and niches
• Super-Private E&P: delisting and absorbing publicly traded E&Ps.

Fifth, we may see a flurry of upstream IPOs in 2022 with market conditions looking favourable again. At least three are on the cards in Europe alone – Neptune Energy, Wintershall DEA and Var Energi. The US Permian is also hitting its stride again, with tight oil production in a new phase of growth. Colgate could go public in 2022, and others will eye the opportunity.

How long can it last? IPOs have been a dependable feature of the cycle for decades, new listed upstream companies replacing those gobbled up by consolidation. That dynamic is going to change as the energy transition tightens its grip. Consolidation will only increase, while new money coming into a sector facing decline will dwindle.

The present, near-perfect market conditions augur well for planned IPOs. Those positioning for a public listing should take advantage sooner rather than later. This upcycle might prove to be the last.