Oil & gas M&A in the US follows global market softening

M&A in the US oil and gas sector faced significant headwinds in 2019, even before the COVID-19 pandemic and crash in crude price sent a shock to the industry

M&A in the US oil and gas industry faced an uphill battle in 2019, and challenges are only expected to increase in 2020, as the ongoing COVID-19 pandemic and a renewed global pricing battle have resulted in a multi-year low in the price of crude.

Even prior to the shock to the market in mid-March, the spotty recovery from the crash of 2014 and emphasis on investor return has led US firms to conserve capital, despite the US becoming the world’s largest oil producer in 2018. As US shale in many basins remains particularly sensitive to oil price volatility, the late 2018 oil price decreases led to a sharp year-on-year fall in 2019 in O&G deals in the US, reflecting the struggles being faced by the sector.

There were 190 transactions involving US O&G targets, worth a combined US$157.9 billion. These represent a 38% and 45% drop in volume and value respectively from 2018, producing the lowest annual totals on both counts since 2015.

The supply shock launched by Saudi Arabia-led OPEC, if prolonged, is likely to hit the US O&G industry particularly hard. US-based operators have already been under particular pressure from the lower oil prices of the past five years—and the cost of production per barrel for US shale operators can be as much as ten times more expensive than Saudi Arabia’s. The situation will be exacerbated by the anticipated fall in demand resulting from COVID-19, which was reducing economic activity, particularly transportation and tourism industries, even before discussions between OPEC+ participants broke down.

Permian prospects

Central to the US energy revolution is the Permian Basin, a sedimentary basin in western Texas and southeastern New Mexico. This oil-&-gas-rich region was the focal point for the largest deal of 2019.

Occidental Petroleum acquired Anadarko for US$54.4 billion including debt, outbidding Chevron. It was not only the largest deal of the decade, but the fourth-largest O&G transaction ever.

Stripping this megamerger from 2019’s figures brings the annual value total to US$103.5 billion, the second-weakest year on Mergermarket record after the nadir of 2008 (US$41.4 billion).

While Occidental became the owner of Anadarko’s prized Permian acreage, it also assumed ownership of non-core assets for which it was expected to seek buyers. US spin-off deals have not yet appeared. The divestment of Anadarko’s African assets to Total, which closed in September 2019, has already raised US$8.8 billion.

Beyond last year’s headline-grabbing Occidental transaction, other momentous deals in the area include Callon Petroleum’s US$3.2 billion merger with Carrizo Oil & Gas; WPX Energy’s US$2.5 billion takeover of Felix Energy II; and the US$2.3 billion all-stock merger of Parsley Energy and Jagged Peak Energy.

Production in the Permian is still dominated primarily by independent producers, which are less well-positioned to weather a prolonged price drop. While many US producers appear to be reasonably well hedged through 2020, an extended low oil price regime into 2021 would be hard for independent producers to manage. Already, many, if not most, US-based firms have announced they are conserving cash and cutting back on capital expenditures and drilling activities.

Private equity seeks O&G related opportunities

PE activity had an exceptional 2019: US O&G buyouts amounted to US$48.5 billion, the highest annual total on Mergermarket record. Volume was mostly flat, recording a slight decrease to 53 deals from 56 in 2018.

The largest PE deal in 2019—and indeed the third-largest acquisition overall in US O&G—was the US$10.2 billion take-private of Buckeye Partners by Australia-based investment group IFM. The proceeds were used not only to pay Buckeye’s existing shareholders, but to refinance some of the company’s debts.

This increase has been attributed to soft oil prices through much of 2019 and lack of access to debt financing. With the recent crash, PE is likely to feature heavily in 2020 deal activity, providing alternative financing amid investor aversion in the equity and debt capital markets. Financial sponsors could also be active in picking up distressed assets—many in the US shale industry have elevated levels of debt, and if the oil price continues to remain low, this is likely to result in an increase in restructuring activity.

Do greener pastures lie ahead?

Rising social demand for cleaner energy, lower natural gas prices and policymakers’ efforts to decarbonize the economy suggest renewables will account for a growing share of M&A in the global energy sector.

In the US, the shale boom and abundance of fossil fuels may have distracted producers and consumers from clean alternatives. The global trend towards cleaner energy, however, is most obvious in Europe and Asia, with China harboring ambitions to be a world leader in clean energy production.

In addition, the US is phasing out government subsidies. Mirroring similar measures in Europe and China, so-called production tax credits (PTC) were used to finance wind projects but these will be phased out in 2020, the last year for claiming PTC benefits. The same is true of investment tax credits, a subsidy for the development of solar projects. These policy shifts may result in a short-term pullback in capital willing to fund such projects, as they have become relatively less attractive.

That said, US renewables deals are becoming more commonplace. For example, the largest US energy sector M&A deal of Q4 2019 was the Canada Pension Plan Investment Board’s US$6.1 billion purchase of San Francisco-headquartered renewable energy firm Pattern Energy. Continued dealmaking in the face of continued withdrawal of fiscal support highlights the self-sufficiency of renewables sources, given that the cost of production has fallen dramatically in recent years. This suggests that, over the medium to long term, investors will be attracted to such development projects, and increasingly without any government support.

The viability of clean energy and the broader will of supermajors to ‘green up’ their portfolios will be a strong M&A motivator. When BP divested its Alaska assets for US$4 billion to Hilcorp Energy in August, in the sixth-largest deal of 2019, it promoted that the move reduced its carbon footprint. The recent drop in the oil price is likely to interrupt this process as O&G firms conserve their capital and asset buyers wait for more clarity in the long term marketplace. Longer-term, however, the need to reduce carbon intensity will be unavoidable—and the resulting move to renewables and increased emphasis on natural gas production inescapable.

Such portfolio reshaping is no fly-by trend, although for the time-being it remains unclear whether recent events will accelerate or decelerate the industry’s reconfiguration.

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