M&A in the oil & gas sector was nothing short of grueling last year. After an impressive showing in 2018, deal volume plummeted by 30% to just 388 transactions in 2019, the lowest annual level on record (dating back to 2006)—just under the previous record low of 389 transactions in 2009.
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Appetite for transactions is tacitly tied to the price of crude, which has been one of the most volatile assets of the last five years, subject as it is to geopolitically motivated supply shocks and macroeconomic signals.
There was just US$251.6 billion invested across these 388 deals, a 34% annual shortfall on a dollar-invested basis and the lowest annual value of the past five years.
In the face of growing public awareness of climate change, oil companies are under unprecedented pressure from shareholders to justify the viability of long-term fossil fuel projects. This is being compounded by the highly visible effects of climate change—the Australian wildfires the latest 'green swan' catastrophe to bring the issue into clear focus.
Despite oil & gas firms’ awareness of the need for energy transition, the industry is by no means abandoning carbon-intensive assets overnight. The largest transaction of the year, Occidental Petroleum’s acquisition of Anadarko for US$54.4 billion (including net debt) was motivated by the latter’s assets in the Permian Basin, now the most productive oil field in the world, thanks to the fracking revolution.
The deal helped boost the US’s status as the most active market for oil & gas M&A in 2019—there were 190 deals targeting US assets over the year, worth US$157.9 billion—nearly half (49%) of global volume and almost two-thirds (63%) of global value. Much of this activity was domestic (156 deals worth US$140.2 billion), including the top two largest deals of the year.
The Permian Basin, which spans Texas and New Mexico, has helped the US overtake both Russia then Saudi Arabia as the world’s biggest oil producer. The Energy Information Administration estimates that the US extracted more than 15 million barrels of oil per day in 2019, above Saudi Arabia's 12 million.
Much of the production in the Permian remains controlled by smaller operators. Whether a scramble for those assets by larger oil & gas firms will emerge depends heavily on commodity prices, but also increasingly on ESG concerns, as fracking’s environmental impact remains contentious.
The climate emergency is also drawing attention to the renewables sector. Utility firms, like Engie, have been active in investing in renewable energy projects.
But oil & gas firms are also making inroads into renewable power as they look to pivot their strategies away from fossil fuels. European oil majors in particular have been stalking renewables assets. Shell and Total both participated in the sale process for Dutch utility Eneco—which is involved in solar, hydropower, wind, bioenergy and clean projects across Europe. Ultimately Mitsubishi and Japanese utility Chubu Electric Power Company were successful in acquiring the company for US$4.8 billion (including net debt) in November.
In what is likely to presage further activity, not only in 2020 but for years to come, Total and Japanese conglomerate Marubeni won a joint bid in January to develop an 800MW solar plant in Qatar. The large-scale development is the first of its kind for the oil-rich nation. Falling costs in both solar and onshore wind mean they are now the cheapest sources of power generation. This fact alone indicates where M&A activity will be concentrated over the long term—and oil & gas firms could become increasingly involved.
Oil & Gas infrastructure a brighter spot
As the pressure to prepare for the energy transition mounts, global oil majors are searching for ways to monetize their assets. At the same time, infrastructure funds are finding themselves flush with cash—unlisted infra funds had dry powder of US$175 billion as of March 2019, according to Preqin. This has resulted in increased interest from funds in midstream pipeline assets. Pipelines generate steady income, ideal for financial sponsors as they look for value outside of their core areas.
In particular, the rise of water management midstream companies creating long-term, permanent infrastructure-based solutions for takeaway, disposal, and recycling capacity have seen rapid growth and strong access to capital and dealmaking as they work to meet the water and reuse requirements facing the exploration and production (E&P) industry—particularly in the Permian. Continued M&A and financing activity is expected in 2020.
Brazil auctions flop
One of the biggest stories in the sector last year was the lack of interest among the global oil majors in Brazil’s much-hyped auctions of production rights to offshore oil reserves, which are estimated to hold as much as 8 billion barrels of crude. These deep-water blocks would have required heavy long-term investment, and with the energy transition to cleaner fuel in mind, global oil majors are far more disciplined with their capital.
Future interest in the privatization of Brazil's oil reserves will determine whether it can remain a key M&A market. In January 2020, on an official state visit, US energy secretary Dan Brouillette said the US was willing to support Brazil in optimizing its auction process, after its bidding rules were criticized for being too complex.
On the other hand, the sale of a 90% stake in natural gas transmission network Transportadora Associada de Gas (TAG) by state-backed firm Petrobras was successful. The stake was acquired for US$8.6 billion by French utility firm Engie and Canada’s Caisse de dépôt et placement du Québec, a pension fund, and ensured that Brazil recorded the second-highest deal value (US$12.8 billion) of any country after the US in 2019.
Oil price outlook bearish
A drawn-out downcycle in the asset precipitated by the shale boom is having a significant impact on the health of the industry. After an initial wave of bankruptcies of North American oil & gas exploration and production companies in 2015 and 2016, following the oil price crash, the situation stabilized in 2017 and 2018. However, 2019 saw a spike to an estimated 42 such company failures as a consequence of a commodity rout in the final quarter of 2018. Oil & gas speculative-grade debt also had the highest default rate of any sector in 2019.
Despite a broadly positive, albeit volatile, 2019, the oil price has taken a turn for the worse. The price of crude plummeted by roughly 15% in the first month of 2020 in what is the biggest January fall in 30 years, then dropped further in February. Just as the outbreak of a new coronavirus in China has given travel stocks a beating, the oil price has sunk in anticipation of a fall in demand.
Any future dealmaking in the industry will not only be constrained by crude prices, but will also be made with a view on the long-term viability of carbon-intensive energy.