The fault's not just in the rocks - where is the Oil & Gas Deals market going?
January 23, 2015
Declining oil prices
In the last six months, the price of Brent Crude has more than halved from over $115 a barrel to under $50, the lowest level since early 2009 during the financial crisis. With little expectation of a rapid rebound, many industry analysts are now assuming that prices could remain low for much of 2015, possibly longer.
A painful time for oil & gas businesses
Lower oil prices will impact discretionary capex (exploratory drilling and field development) and profitability, with a tightening of cash in both the exploration & production (E&P) and oilfield services (OFS) sectors.
Businesses feeling the pain from cash constraints may need to turn to the debt markets for help. New debt will come at a cost and may be provided using debt structures and by providers not typically seen in the sector. Existing debt will come under increased scrutiny and increased risk of covenant breach - readers of accounts will need to understand the associated risk as they assess future oil price scenarios. Reserve-based lending (RBL) in particular will be more expensive and less accessible, as banks adjust their base oil price assumptions down for lending. I expect banks to provide some support to the industry as this is a global – not just UK – problem.
Debt may not be the only solution, as equity injections may be needed in some cases to fix capital structures.
Through the Q1 2015 reporting season, companies will need to reassess their commercial reserves and I anticipate more impairments and write-offsacross the industry. Different companies will adopt different approaches, but the reduction in capital expenditure (capex) is already hitting OFS and asset-heavy businesses hard. Watch out for the impact of reduced gross assets on reported gearing and net asset covenants. Also, large scale write-offs may fundamentally alter company balance sheets.
I expect a lot of contract discussions as companies seek to modify (or tear up) existing contractual relationships. While everyone recognises something needs to be done in the sector, not all of these discussions will be straightforward or at no cost...
Will it impact M&A activity too?
Yes. Whilst the current environment has disrupted the existing M&A activity, in the medium term, deals will be a solution to some of the current problems.
Initially companies will consider whether debt and/or equity issuance can solve short term challenges. Thereafter asset sales will be a consideration, but the traditional funding fix of farm-outs or carries will require oil price stability in most cases, except for distress scenarios priced as such.
Expect larger scale deals to achieve operational synergies and cost reduction:
The E&P sector will see deals shift from smaller marginal fields that made sense at high prices, to consolidation, with an increasing number of paper-based transactions and some transactions involving small independent E&P players.
The supply chain will come under increased focus: while cost reduction programmes are already underway, M&A remains a clear way of achieving substantial cost reductions. Deals will happen when a degree of pricing stability returns, whenever this may be.
Distress sales:
With the current volatility and uncertainty over future oil prices, a number of troubled businesses may be forced to take action in 2015. I anticipate more distress sales and opportunistic (and potentially hostile) public bids for companies with good underlying quality assets but the wrong financing structure. OFS companies focused on exploration (as opposed to production) are also likely to come under pressure.
New sources of capital:
Sovereign wealth funds, state-owned enterprises (the national oil companies, NOCs) and specialist energy funds are all sources of capital that the industry will badly need. Inbound investment is likely to step up as cash-rich institutional and private investors look for bargains, new opportunities and value plays. Expect cash-absorbing businesses to be snapped up by opportunistic bidders who have the luxury of a longer term outlook and are able to take a view on the long term oil price.
How will the oil price affect you? What changes to strategy have you made? Share your thoughts below or schedule a meeting to discuss your situation in confidence.