The Edge

Upstream M&A erupts - Intensifying activity is strengthening portfolios and finances

Puffs of smoke a year ago indicated a reawakening of the M&A market. A full blown volcanic eruption has duly followed, deals pouring out of the US Lower48 and activity spreading out across the globe over the last few months. The industry needed it - higher transaction liquidity as well as access to capital markets is helping strengthen balance sheets and portfolios. Business development teams are back in the front line as companies look to position for longer term growth.

Spend on M&A has soared back close to all time highs. The nadir in Q1 2015 saw just US$5bn of transactions. In the immediate aftermath of OPEC’s fateful meeting at the end of 2014, the industry effectively stopped doing business. Confidence was low, uncertainty was high, and there was no access to finance. Fast forward eighteen months and it’s as if those dark days never happened. The total sum of global M&A transactions in each of Q4 2016 and Q1 2017 touched US$60bn, among the top ten quarters ever by value.

This is no feeding frenzy of the kind that can happen when the market reaches heightened levels of activity.

There are pleasing patterns to the types of deals being done.

First, the right assets are moving into the right hands as Greig Aitken, our Head of M&A Analysis, has pointed out. Oil sands is a prime example, a resource theme with cost and environmental challenges. ConocoPhillips, Shell, Marathon and Statoil have sold US$20bn of oil sands assets this year. The buyers are domestic Canadian producers, scooping up assets in which they can apply their core competencies to maximise economies of scale and value.

Shell’s US$3bn sale of a North Sea package, including mature, tail-end assets, is a similar story. The private equity buyer is far more leveraged to any upside from wringing out value from cost cutting, deferring abandonment and incremental investment.

Second, companies are consolidating existing advantaged positions. The US Permian Basin has been the global hotspot with US$38bn of transactions in the last nine months accounting for a quarter of all M&A spend. Marathon, EOG and ExxonMobil have all increased exposure to tight oil growth through acquisitions.

As a counterpoint, private equity has been a seller of tight oil into strengthening asset prices (US$19bn in the last nine months). Valuations have risen from a few thousand US$/acre two or three years ago to over US$50,000/acre in recent deals.

There is some evidence that private equity thinks the easy money in tight oil has been made and the value opportunity is shifting to US upstream gas.

Thirdly, there is positioning for long term growth, notably by the Majors. Shell’s acquisition of BG was primarily about pre-salt Brazil; acquiring future production low on the cost curve. Others have followed the template in smaller scale, notably Total (pre-salt Brazil and Uganda) and Statoil (pre-salt Brazil). ExxonMobil’s entry into the Mozambique Area 4 greenfield gas project is more about broadening its exposure to another giant gas resource to grow its core LNG position.

The availability of capital has been a key factor behind the increased activity. Tight oil has been a big draw for equity funding, ExxonMobil, EOG and Marathon among the many, mostly independents, tapping the market. Cenovus and Canadian Oil Sands used equity to fund part of their deals, though financial leverage for each will increase. Both are committed to asset sales to reduce debt.

The flow of sales is helping the sector rebalance its finances.

Shell is now two thirds of the way to its US$30bn disposal target set at the time of the BG acquisition, having monetised a mix of upstream, mid-stream and downstream assets. ConocoPhillips has raised US$16bn solely from upstream this year alone and the cash proceeds will cut leverage from 42% to below 20%.

That the M&A market should be so buoyant with an oil price marginally above US$50/bbl reflects how far the industry has come since 2014. Confidence has been restored, to a degree, among capital providers, by self help rather than the belief that oil prices will rise any time soon. A continued focus on cost reduction, capital discipline and portfolio high grading could help sustain a busy M&A market for some time yet.