The Deals Lens - Cast Iron Underpants: Deals in the current oil slump
January 19, 2015
With prices dropping under $50 a barrel, the pain has to filter down. And it is. Frontline projects are being shelved and mothballed. The depth and speed of the plunge though, means pressure will be keenly felt in areas previously perceived as more insulated from the spot market.
Companies that don’t sell oil themselves but are dependent on activity within the sector are vulnerable. The equipment and services sub-sector, for example, is made up of enterprises that provide infrastructure, testing, generators, life rafts, pipes, IT and helicopter rides. They will see revenues fall as capital investment retreats and costs are cut. The longer the price stays low, the further the pain will creep down the chain. Helicopter leasers take note.
Asset write downs?
Another nervous group is private equity houses that completed highly-leveraged deals in the wider oil sector over the last few years. Pricing agreements and contracts with the oil producers will inevitably be renegotiated downwards. There will be asset write downs and failures will result in banks holding some assets and new financiers being needed.
Is now the time to buy oil?
On the other hand, for those who want to get into the oil game, is now the time to buy? You may need several pairs of ‘cast-iron underpants’, but prices for oil industry debt, equity and assets are coming down fast. Sovereign wealth funds, oil-interested private equity houses and specialist financial investment funds are watching closely because they know that someone will have to do something with businesses stranded by receding prices. Taking a longer term view, surely oil prices will head back to levels seen in recent years, despite what forward prices suggest today.
If you are considering getting into oil, due diligence will make the crucial difference between striking (black) gold and making an expensive mistake. Look closely, for example, at the extractive challenges of the customer portfolio for the investment you’re considering. Those companies working in fields where oil is particularly difficult to get at will inevitably become unviable sooner than those where the process is easier. The more accessible wells will nudge back into profit sooner too, when oil prices do rise, as surely they will.
A final view beyond the industry
The flipside to all of this is that energy intensive industries will feel the benefits: oil refineries, the chemicals industry, airlines, holiday companies, railways and European manufacturers. How long they remain more profitable will depend on how long oil stays low and the extent and rate they pass these on to their customers in the form of lower prices. Just don’t assume their new level of super profitability will be around for too long.
What’s your view? Will you be donning cast iron underpants & investing in oil? Or are you starting to see revenues fall as the oil majors tighten their belts? Share your thoughts in the comments box below or schedule a meeting to discuss your concerns in confidence.