by Timothy Lloyd
A May 2015 PricewaterhouseCoopers analyst report on M&A activity in the oil & gas industry through Q1 of this year portrayed a stalling deal-making environment. In a geopolitical backdrop where the U.S. is focusing punitive and, at times, ambiguous financial sanctions against Russia, a country that depends on $90 oil to meet its economic targets, and a Saudi-influenced OPEC ideology that favors keeping production levels unchanged, oil prices have experienced persistent instability and declines in the last year.
Oil’s price uncertainty has continued into 2015 and these slumping market conditions make prolonged asset-holding strategies more appealing to E&P executives, who seek price stabilization, pre-sale. The commodity hit a low of $46 in January, according to Time, and seems to have encountered a resistance point at $60 at the time of this post. But, declines in transaction activity belie hidden opportunities and alternative private equity movements in the space.
The PwC report found that total deal flow in the upstream sector, which refers to exploration and pre-production operations, declined significantly in Q1, accounting for 12 transactions valued at $3.6 billion. These figures represent a drop of 60 percent and 71 percent in total deal volume and value, respectively, compared to Q1 of 2014. Doug Meier, PwC’s US energy sector deals leader, said that oil company executives were focusing on “cost reduction and productivity enhancement activities, which have taken attention away from M&A as a growth vehicle.”
But, more intriguing, E&P industry experts like, Kirkland & Ellis Partner Amber Meek, contend that E&P private equity investment never declined. “It’s really more that a lot of our clients started pivoting,” she told Oil and Gas Investor in a May 2015 story. Meek said that PE firms are eschewing “working interest” acquisitions and instead, opting to purchase into debt or securities of public companies through PIPE (Private Investment in Public Equity) transactions.
A separate Oil and Gas Investor article, also authored in May, highlights Eclipse Resources Corp.’s innovative refinancing initiative where they generated $440 million of capital in an equity sale to EnCap Investments through a PIPE transaction. Despite certain share dilution, the maneuver helped Eclipse avoid the financing mistake of issuing more debt in a volatile and unsustainable yield environment, and enabled the company to start 2015 net-debt-free.
Another PE oil & gas industry expert, Quantum Energy Partners President and CEO Will VanLoh, thinks the sector can be profitable in its current price climate. He told Oil and Gas Investor, in its April “Private Equity Prospects” report he thinks “within 12 months, many of the plays that were uneconomic at $50 per barrel are going to be economic again.”
“And with service costs coming down to whatever levels are needed to get rigs running again, the U.S. oil and gas industry is going to be able to make good returns in a $50 to $60 per barrel price environment. This is one of our arguments as to why we don’t see oil prices shooting back up to where they were any time soon,” he added.
Quantum’s latest fund, Quantum Energy Partners VI, which raised close to $3.4 billion in equity funding, has made 3 investments valued at $1 billion overall. However, the more imminent opportunity for PEs is in oil and gas companies who are overleveraged, and who lack the cash flow to endure this bearish market cycle in tact. These are ideal carve-out and takeover candidates for PEs, as distressed-E&P bank creditors will pressure them to sell assets to fulfill their debt obligations.
Another promising theme for prospective E&P private equity investors is the midstream subcategory, which includes the processing, storing, transporting and marketing of oil & gas resources. According to the PwC report, Q1 2015 saw 22 midstream deals, approaching $29 billion in value, or a 47 percent spike in deal volume and a 398 percent increase in deal value compared to Q1 2014. Master limited partnerships and related transactions accounted for 45% of midstream deal value in the first quarter of 2015.
And for private equity investors looking for exposure to the shale subcategory, the Permian in West Texas was the most active M&A region for deals in excess of $50 million in Q1 2015. In the first quarter of this year, the Permian registered 4 deals worth $1.5 billion. But, the Eagle Ford region was a close second, registering deal flow valued at $1.2 billion.
The final factor private equity E&P investors need to consider is how Greece’s default fears are creating a rising dollar economy. According to a June Dow Jones Business News article, the relationship between the greenback and oil prices is generally an inverse one. And as Greece jitters reduce investor confidence in the Euro Zone, the dollar is bound to appreciate and exert further downward-pressure on crude prices.
While uncertainty is a daily reality in the current E&P market environment, private equity transaction activity should pick up in 2015. Continued price repression will smoke out cash-hungry oil companies, looking to divest assets, even at discount rates. Additionally, PIPES and alternative private equity deal structures might present attractive opportunities for PE investors. In the short-term, however, expect the emerging tropical storm season to provide some desirable price support for opportunistic oil & gas executives.
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