Barrels Of Opportunities
If the history of mergers and acquisitions is anything to go by, then the times of oil price slumps, have witnessed few of the most memorable mergers and acquisitions in the oil and gas space. The oil price crashes in the early 80s and late 90s triggered a series of high profile mergers that led to a change in industry structure. Just like with any commodity market, the weakness is the energy sector leads to a weak energy stock market, which makes it easier for the companies with strong balance sheets to make acquisitions vertically and horizontally. The sharp drop in prices during the1990s, resulted in the consolidation of the super majors, such as BP acquired Amoco and Arco, Exxon bought Mobil, and Chevron Corp. acquired Texaco.
With the current oil prices down by 40% from their highs in June, history seems to be repeating itself. Last week the Spanish energy giant Repsol and Talisman energy started negotiating about a potential acquisition. Other potential deals that have surfaced recently are, Halliburton Co.’s bid of $35 billion to acquire Baker Hughes Inc., Royal Dutch Shell’s bid for BP PLC.
My research led me to look into the year 2007–2008’s oil crash, and its effect on the Canadian M&A activity. In 2008, a major drop in oil prices was experienced as they plunged 60% in mid-year; however the volume of deals as well as the number of M&A deals in 2008 weren’t affected (evident from the Bloomberg Data) .The decline in the number of transactions in 2009 was mainly due to the tight credit markets as the world went through the economic recession
THE RATIONALE FOR M&A IN WEAK ENERGY MARKETS:
Weak energy markets present excellent opportunity for Mergers and Acquisitions for the following reasons:
Divestitures: According to the experts, oil prices below $60, put many small and medium -size companies into a distressed situation that forces them to divest their assets. A huge amount of CAPEX investment is required from the E&P companies. Over the last few years, Canadian companies have been willing to consider projects if they could sell the projects oil for $90 a barrel. But with the current oil prices, lots of E&P companies have cut down their outlook for CAPEX spending in 2015. On average, the Canadian E&P companies would be spending 35% less in 2015 than they did in 2014, which would lead to abandoning of lots of projects and properties.
A look at the futures market also shows that hedging for oil prices above $80 has become a challenge; hence the companies have begun to cancel their projects. Oil prices at a five-year low are leaving oil producers with no choice but to sell assets or seek outright takeovers, though the asset valuations might even be lower than the book values .
Leveraged: Most of the Canadian oil and gas exploration companies are highly leveraged with debt to cash flow ratio of three to four times. With such amounts of debt and prevailing oil prices, these companies are finding it hard to stay afloat and provide an opportunity for an acquisition. Some vulnerable names are Penn West, MEG Energy and Baytex Energy. They may consider asset sales as their capital expenditures and dividend payments exceed expected cash flows at current prices.
Low Valuation: Due to the low valuations in the stock market with few of the companies experiencing as much as 75% of their market cap being wiped out, along with tight credit markets, again present opportunities for consolidation. As the world oil reserves continue to deplete, many large companies grow inorganically by acquiring smaller companies with proven reserves and drilling infrastructure already in place. Oil executives say their profits have started to suffer, as oil fields around the world have begun to age producing less oil. This forces the exploration companies to drill in deeper oceans and more remote places such as the Arctic to keep up with production which costs more money. That’s the reason; inorganic growth is becoming popular as it is a cheaper way to maintain a company’s current cash flow without needing to drill new areas.
Future opportunities:
According to the analyst estimates, average oil price is expected to be around $80 in 2015, suggesting that the current low prices are not the new norm. Western Canada’s premium shale fields, where the fracking technology has uncovered huge shale reserves, present another great opportunity for M&A activity as the oil prices rebound.
Risks:
The biggest impediments to the Canadian Oil and Gas industry are the lack of major pipelines that can access key markets such as the United States to the south or exports on the coasts. The other thorn in the bush for the Canadian deal makers are the restrictions the government has placed on investment by foreign state-owned companies. In the current scenario of low oil prices and valuations, we could see quite a few of joint ventures and foreign take overs of the Canadian E&P companies if Ottawa clears its murky stance on the foreign takeovers.