During 2008, oil and gas M&A activity levels and transaction values were principally impacted by three factors instability in inancial markets, volatility in oil prices and a weakening global economy. In the high oil price environment of the irst six months of the year, oil and gas M&A activity was buoyant with 670 deals announced with a combined value of US$90b. However, the level of deal activity slowed in the second half of the year as the full impact of the inancial crisis began to bite and oil prices fell from record highs on signs of slowing demand.
In total, 1,094 transactions were announced in 2008. The volume of deals was down 29% on the previous 12 months, although 2007 was a record year for oil and gas transactions activity. The total value of transactions globally in 2008 was US$179b, some 46% lower than the total for the previous year. Upstream deals accounted for over 61% of the value of all announced transactions compared with 47% in 2007.
Corporate oil and gas valuations have been hit hard by the sharp fall in oil prices and the
wider sell-off in equities. The market turmoil will open up new acquisition opportunities for the cash-rich players. Reserves seeking National Oil Companies (NOC) have become more active again in the market now that targets are more affordable. However, we are not likely to see a repeat of the mega-mergers that reshaped the competitive landscape in the late 1990s.
The global economic downturn may lead to a slowdown in oil and gas activity in the next 12 months but the longer-term fundamentals for the oil and gas sector remain favorable.
Upstream oil and gas transactions review
A year of two halves for oil and gas M&A activity
2008 was a year of two contrasting halves for global M&A activity in the oil and gas sector. As the economic outlook worsened in the irst half of the year, oil stocks were temporarily insulated from the full impact of the sell-off in equities by rising oil prices, with Brent crude peaking at a new record high of US$144 per barrel in July.
In the first six months of the year, oil and gas deal activity was strong with 446 upstream deals
announced with a combined value of US$48b.
However, since the summer of 2008, unprecedented events have unfolded in financial markets, the effects of which have been compounded by the looming threat of recession in some of the largest developed economies. Continued uncertainty about the health of the global economy has helped moderate oil demand growth and sent oil prices tumbling.
These factors led to a slowdown in oil and gas M&A activity through the fourth quarter.
Over the course of 2008, upstream oil and gas M&A activity registered a 28% decline in volume compared with the record level of activity seen in 2007. Globally, the 703 deals announced in 2008 represented a ive-year low in the deal count. However, the level of deal activity still represents an average of almost two deals per day. The combined value of announced deals in 2008 was US$110b according to data from IHS Herold Inc. This compares with US$155b in 2007 when the average oil price was some 25% lower than the average for 2008.
Largest deals aimed at securing
unconventional resources
The top 10 upstream deals by transaction value in 2008, accounted for 32% of the value of all deals in the sector. The total value of the 10 largest deals in 2008 was US$35b, down on the US$59b price tag of the top 10 deals in 2007. There were a total of ive deals with a transaction value of greater than US$3b over the year.
The largest announced transactions were Royal Dutch Shell’s US$5.8b acquisition of Canadian company Duvernay Oil and ConocoPhillip’s US$5b initial investment in a joint venture with
Australian company Origin Energy. These two deals illustrate the investment some International Oil Companies (IOCs) are making in unconventional resources as access to conventional oil and gas
reserves in certain countries is off-limits to foreign investors or is available on less favorable terms.
North America continues to be the most active market
A little over 80% of all upstream deals announced in 2008 were in North America. This was a higher proportion than in 2007 despite a signiicant decline in the number of Canadian deals. The value of transactions that took place in Canada, at US$15b, was 68% lower than the value in the previous year. Canadian M&A activity was hit by the rising cost of oil sands projects in the first half of the year and the weaker economics of these projects in the lower oil price environment of the second half of the year.
The number and value of upstream transactions in the United States held up well in 2008. The M&A activity was buoyed by takeovers of some smaller independent producers, asset deals and interest in onshore shale plays. Outside of North America,
activity was strongest in Europe where there was a 5% increase in the deal count. The Australia and Oceania region saw the largest increase in total deal value in 2008, which at US$16b was over 12 times higher than in the previous year.
Two of the highest value deals in 2008 involved Australian companies including BG Group’s
acquisition of Queensland Gas Company, which followed an unsuccessful takeover bid earlier in the year for Origin Energy. The Australian company chose instead to partner with ConocoPhillips, as discussed earlier.
Asset deals are more prevalent
Asset deals were more prevalent than corporate transactions during 2008, relecting IOCs’ need to grow reserves and higher valuations for most companies in the sector as the oil price rose.
In total there were 585 asset transactions in the upstream sector compared with 118 corporate deals. The total value of global asset transactions in 2008 was US$76b while the comparable figure for corporate deals was US$34b. Both the number of deals and the total value of transactions were lower across both types of deal in 2008 compared with a year earlier.
Reserves seeking national oil companies are
re-emerging in M&A market
After a year-long hiatus, Chinese and Indian national oil companies (NOCs) are beginning to make acquisitions again now that targets are more affordable. Russia-focused independent Imperial Energy was the US$2b target of India’s ONGC, in the largest announced corporate transaction by a NOC in 2008. Typically, NOCs are not reliant on debt to inance acquisitions, which is likely to give them a competitive advantage in 2009.
Oil company valuations hit by oil price volatility
The average Brent crude price in 2008 was US$96.87 per barrel, a record for a year that was characterised by signiicant oil price volatility. Over the course of the year, oil prices reached a new record high but also plunged to a four and a half year low. From July, concerns over weakening global economic growth and the mpact on oil demand set oil prices on a downward trajectory.
At the end of the year, the Brent crude price was 74% below the record high and some 60% lower than at the start of the year.
Oil and gas company stocks have been hit by the sharp fall in oil prices. Particularly hard hit were junior oil and gas companies, which, regardless of size and development status, saw their share prices razed in the third quarter.
Hedge funds and specialist resources funds, faced with investor redemptions in response to the falling oil price and an increasing aversion to risk, reportedly liquidated their positions in many resources stocks. Such funds, with a focus on longer-term gains, have historically been important sources of investment for junior resources stocks.
Outlook for 2009 is mixed
Oil price volatility is likely to persist into 2009. This may result in greater misalignment in asset valuations between buyers and sellers, which could continue to impact M&A activity through 2009. However, although the global economic downturn may lead to a slowdown in oil and gas activity in the next 12 months, the longer-term fundamentals for the oil and gas sector remain positive. Any slowdown in development activity now will only delay
the investment that is required to satisfy the world’s need for long-term, reliable supplies of hydrocarbons. The crisis could help alleviate some of the services and equipment cost pressures that oil and gas companies have been facing in the last 18 months.
The inancial crisis may also accelerate the long-expected consolidation in the junior oil and gas sector. The oil majors will be keeping a close eye on valuations during the crisis but will
probably proceed cautiously with any acquisitions. In recent years, opportunities have typically been the main constraint for the larger oil companies rather than cash. The current market turmoil will open up new acquisition opportunities for the cash-rich players – supermajors, NOCs and sovereign wealth funds (SWFS).
Acquisition targets are likely to include distressed companies that are reliant on debt or equity for funding. However, we are not likely to see a repeat of the mega-mergers that reshaped the competitive landscape in the late 1990s.
Downstream and midstream oil and gas
Signiicant decline in transaction activity
The downstream and midstream sector saw a signiicant decline in both the volume and value of transactions in 2008, compared with the previous year. There were just 201 transactions in the sector in 2008, some 39% lower than the level of a year earlier. The combined value of downstream and midstream transactions was 65% lower at US$38b.
The buyers involved in the largest downstream and midstream transactions were a diverse group including utility companies, chemical companies, private equity (PE) firms, financial institutions and oil companies. The top 10 deals in the sector during 2008 had a combined value of US$19b, accounting for some 51% of the value of all transactions in the sector globally. The largest deal was German chemical company BASF’s announced
acquisition of Swiss specialty chemical company Ciba Holding. The most actively traded type of downstream assets were those concerned with natural gas distribution. In one of the highest value deals in 2008, the Turkish government sold a natural gas distribution network for 70,000 customers in the capital Ankara.
There was a signiicant decrease in the both the volume and total value of corporate deals in the downstream and midstream sector in 2008 compared with the previous year. In a reversal of the situation in 2007, the value of asset deals in 2008 was higher than the value of corporate deals. The total value of asset transactions in the sector in 2008 was US$21b, compared with the US$17b value of corporate deals. The largest proportion (77%) of deals was carried out in the United States. There were no cross-border deals announced in 2008.
M&A activity in 2009 is likely to be subdued
The major integrated oil companies are likely to continue the divestiture of retail assets in non-core markets into 2009. Plans by the integrated majors for the expansion of their retail presence in developing markets will be scaled back as these economies are also experiencing a slowdown in economic growth. In a capital-constrained environment, investment in the downstream sector is likely to be trimmed as preference will be given to upstream projects that add long-term volumes. The economic slowdown and resulting fall-
off in demand for petroleum products will likely lead to delays or the cancellation of some
projects, particularly those involving the addition of new reining or petrochemical capacity
or the upgrade of existing reining capacity.
Considerably weaker global reining and chemical margins compared with the highs seen in recent years may make these assets less attractive to potential buyers. Marketing assets may also be less attractive in the current environment as throughputs are likely to be lower as consumers and businesses reign in spending.
Oilfield services
Deal activity slows in weaker commodity
price environment
The oilfield services (OFS) sector has beneitted from several consecutive years of double-digit growth in exploration and production spending by oil companies. 2007 was a record year for M&A activity in the OFS sector and 2008 had been on track to be another bumper year before the collapse in oil prices.
The number of OFS transactions announced in 2008 was 18% lower than in the previous year. The total value of the 190 OFS deals reported last year was US$31b, some 54% down on the record
value realised in 2007. OFS M&A activity was strong in the second quarter when the only direction for oil prices seemed to be higher.
The OFS sector received an unparalleled level of interest from PE investors and increased attention from oil-backed sovereign wealth funds during the irst half of 2008, as exempliied by
Umbrellastream’s US$3.6b acquisition of Expro International.
Consolidation activity continues
There was more than double the number of corporate deals compared with asset deals in the OFS sector in 2008. The total value of the 133 corporate OFS transactions in 2008 was US$25b,
a little over 57% lower than the combined value of the 145 transactions in the previous year. The total value of OFS asset deals in 2008, at US$6b, was down 22% on the comparable figure for
2007.
Of the 10 largest OFS deals in 2008, all but two were corporate deals. These eight corporate transactions had a combined value of US$18b, representing 92% of the total value of the 10 largest deals and 58% of the value of all OFS deals. The largest OFS transaction by value during 2008 was China Oilield Services’ acquisition of Norwegian company Awilco Offshore ASA.
The majority of consolidation activity in the sector during 2008 has been about positioning for growth and the reinvestment of stronger cash lows. The established diversiied OFS companies are being challenged by a new breed of ‘super’ drilling and engineering, procurement and construction (EPC) focused organisations, which
are the product of mergers between some of the largest players.
Shifting from localised service offerings
84% of OFS transactions in 2008 occurred in the North American market. The 159 North American deals had a combined value of US$5b. The opportunities provided by NOCs are a key driver of changes to the geographical focus of OFS companies.
OFS companies which are focused on one particular region will find it more dificult to weather a downturn. Most OFS companies are currently headquartered in the United States or Europe and for many a signiicant proportion of their earnings is derived from their domestic markets.
There remain opportunities for OFS companies in countries where IOCs have been frozen out or where there has been a prolonged period of underinvestment in the oil and gas sector. OFS companies have an advantage over IOCs in that they do not need ownership of reserves.
Outlook for 2009
OFS sector prospects for 2009 will be inluenced by the level of development activity and spend by oil and gas companies. Capital expenditure-related projects will be inluenced by OFS clients’ capex decisions, and operating expenditure will be under gross margin pressure.
There are signs that some oil and gas companies are scaling back capital investment plans for 2009. In addition, there have been delays on the inal investment decision (FID) for some projects.
Fewer new projects will be sanctioned at oil prices below US$50 per barrel. Some oil and gas companies are also re-tendering work on large-scale projects in anticipation of easing equipment and service costs. Marginal projects in mature areas will be among the first casualties of any slowdown in E&P spending by oil companies.
Crucially though, the oilield services sector is in a stronger shape than in previous downturns and is better placed to deal with the challenges ahead. Some OFS companies will be sheltered from
the impact of any slowdown in activity by oil and gas companies in the next year. Long-term contracts currently underpin many OFS companies’ returns in some key segments However, there is
likely to be pressure on margins on new projects as the contracted backlog is worked through.
The market and oil price uncertainty may put the brakes on further mega-mergers but there remains an appetite for deals involving small to medium-sized OFS companies. Companies that had taken on debt in order to inance growth may now be vulnerable.
A number of the larger OFS companies have publicly declared that they are more actively considering or pursuing strategic acquisitions.
The acquisition intentions of OFS companies are
driven by two main factors: a need to scale up global capabilities to meet the forecast demand; and accelerating demand for advanced technology to ill product and service gaps among the large
integrated players.
Author: Ernst & Young
