2018 Annual Review

Signs still point to a brighter future in oil & gas M&A

Despite a year-end dip, the pieces are in place for oil & gas M&A to enjoy a busy 2019

While declaring a complete rebound in oil & gas M&A might be premature, recovering prices and price stabilization should continue to spur the oil & gas M&A dealmaking activity that was picking up in the third quarter of 2018 into 2019 and beyond.

After a steady rise in US oil & gas M&A in the first three quarters of 2018, Q4 delivered an unhappy surprise: Autumn forecasts revising demand downward—coupled with a falling stock market, rising interest rates, US-China trade tensions and the revival of US sanctions against Iraq—sent the price of oil plummeting, and oil & gas dealmaking with it.

But Q4 may have brought a healthy correction. Low oil prices are putting the brakes on the building of new production facilities in the US, curbing fears of oversupply. A likely recovery in oil prices—predicted to remain range-bound, but at the upper end of the range—looks set to brighten the outlook for oil & gas M&A by reducing the bid-ask spread and creating a more deal-friendly M&A environment. In addition, announced reductions in capital expenditures should improve free cash flow in the short term and result in a further reduction in any oversupply in the system.

Oil price stability creates an environment conducive to M&A, as buyers and capital providers gain confidence in the possibility of an upward trend in prices. With flatter strip pricing and an easing on backwardation, sellers may also perceive little upside in retaining non-core assets. Renewed fundraising pressures in oil & gas-related private equity may also fuel M&A activity, as firms look to return capital to investors.

The explosive growth of US shale over the past decade has resulted in a highly competitive, fragmented market. As it has matured, the market has benefited from falling production costs, increased efficiencies and technological advances, all causing the industry to thrive despite commodity pricing pressure.

At the same time, the sector‘s so-called "supermajors" have been dialing back on exploration and have made budget cuts in order to long-cycle projects to weather the low-price environment—meaning their conventional crude reserves have waned and need replacing. In many cases, it is cheaper for the supermajors to make acquisitions in the shale space, which is primed for consolidation, than to bring new projects online.

This has resulted in strong M&A interest, particularly in the Permian Basin in West Texas, where production has roughly tripled since 2011, according to the US Energy Information Administration (EIA). In January 2018, ExxonMobil announced plans to increase its shale oil production in the basin fivefold, to 500,000 barrels a day, by 2025. Royal Dutch Shell has disclosed plans to spend some US$2.5 billion a year on US shale assets, about one-tenth of its total spending. In late 2018, BP completed its acquisition of BHP Billiton's unconventional assets, and Chesapeake is expected to complete its acquisition in the Eagle Ford Shale in February 2019. Transactions such as these will further drive M&A activity, as large acquirers seek to rationalize their balance sheets and divest "non-core" assets.


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