Oil price drop set to spur shake-up but M&A high-risk – sector sources

12 Jan 2015 – The plummeting price of oil means the sector will be an M&A hotspot in the year ahead, but there are challenges due to the dynamic nature of the market, sector sources said.

The price of Brent Crude was down to USD 47.86 per barrel on Monday, 12 January, less than half its price of USD 110 in June 2014.

While several sources reported high levels of potential activity, all admitted that deals would be difficult. There is too much uncertainty for many buyers while sellers do not want to sell until they have to, said two bankers.

In December and January two potential deals were pulled – Dragon Oil’s [LNO:DGO] bid for Petroceltic [LON:PCI] and KazMunaiGas EP’s [LON:KMG] takeover by its state-owned parent company – due to market volatility.

Many are temporarily insulated from the oil price falls due to hedges in place through the first quarter of 2015 and into the second quarter, several sources said. These hedges, coupled with price volatility, may delay activity until the latter part of the year.

High-cost production will now not stack up and a number of groups are looking to abandon riskier exploration, focussing instead on safer options, said one source. The price fall will expose those exploration and production companies with weak business plans, a second source added.

Some are already displaying signs of distress. The recent price declines have tipped the already beleaguered Norwegian Energy Company (Noreco) over the edge, pointed out a third source. The group recently announced a comprehensive restructuring as the group’s debt cannot be supported by underlying cash flow and asset values.

Cash rich groups such as Ophir [LON:OPHR], Cairn Energy [LON:CNE] and Riverstone are potential acquirers, said the first source. As at 30 June 2014, Ophir – in the process of buying GBP 157m (USD 237m) market cap Salamander Energy [LON:SMDR] – had USD 1.5bn of net cash, cash equivalents and short-term investments, while Cairn had net cash of USD 953m as at 30 September 2014.

Spanish group CEPSA – which also looked at buying Salamander – is a likely buyer, said two sources. Another Spanish group, Repsol [BME:REP] will be tied-up with its recently announced USD 8.3bn acquisition of Talisman Energy [NYSE:TLM, TSE:TLM], they added.

Vulnerable groups are those that have a high break-even price, said the sources.

A fourth source suggested two such examples are North Sea focussed Iona Energy [CVE:INA] and EnQuest [LON:ENQ]. One analyst estimated the operating cost for the Huntington field – Iona’s key asset – is around USD 30 per barrel (excluding development costs). EnQuest has hedged 8m barrels in 2015, while Iona also has a proportion of its 2015 volumes hedged at a USD 80 per barrel floor.

BG Group [LON:BG] is seen as a perennial target, according to several sources. With high quality assets, it faces the issue of having the capital, internal resources and infrastructure to monetise its acreage, according to the first source. With a GBP 28bn (USD 42bn) market cap, it would need a large buyer, he noted.

One rumour that has recently resurfaced is that of a tie-up between majors BP [LON:BP] and Shell [LON:RDSA]. Most of the sources downplayed the likelihood of such a deal happening, reasoning that neither party was under pressure to take on the significant execution risk of such a deal. BP’s near 20% holding in Russia’s Rosneft and ongoing US litigation relating to Deepwater Horizon may also be problematic.

Oil services groups are likely to see the biggest impact from the oil price falls, particularly small and medium-sized players, several sources said. Rig rates are dropping due to a surplus of rigs, two sources said. One major oil group has slashed the rates it pays to contractors by 10% while others are trying to wriggle out of contracts, said the sources.

Wood Group [LON:WG] is an interesting company to watch in the services space, said the third source. In December the company said it was actively looking for acquisitions, but had tightened its criteria.

Last month Italy’s Eni [BIT:ENI] put plans to sell its controlling stake in Saipem on hold following the cancellation of the South Stream project and falling oil prices.

Spokespeople for the companies declined to comment.

Alongside the North Sea, the region that will see most M&A is onshore North America, following the Talisman/Repsol deal, according to an oil and gas investor. A number of other deals in the region have been announced in recent months, most notably among services groups Halliburton [NYSE:HAL] and Baker Hughes [NYSE:BHI].

In Africa majors are continuing their hunt for upstream assets, with Total [EPA:FP] looking in Kenya and Shell looking in Mozambique and Namibia. Nigerian group SEPLAT [LON:SEPL] recently confirmed its interest in Afren [LON:AFR]. In Nigeria marginal field divestments are expected, through the licensing round.

Meanwhile Kurdistan is seen as ripe for consolidation, particularly in the mid-cap space, following a deal between the semi-autonomous region and Baghdad on oil revenues, said the third the source. Mid-cap groups in Kurdistan include Gulf Keystone [LON:GKP] and Genel Energy [LON:GENL].

In the Middle East, the Gulf has the lowest cost of production for oil and upstream development is set to continue, according to a UAE-based banker. There will be a slow down (of the economy) but this won’t lead to a bust. This is not a 2008-to-2009 scenario, he added.

by Julie-Anna Needham, Katie McQue and Rupert Cocke

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