Will plunging oil prices increase energy M&A?

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The recent sharp fall in oil prices, which has seen Brent crude oil and US crude oil both fall below $50 a barrel, has shocked the oil industry. Growing US shale production and high Organisation of the Petroleum Exporting Countries (OPEC) output, combined with weak demand in Europe and Asia, have contributed to a price drop of more than 45% from recent highs. While the full ramifications of the new market conditions are yet to be seen, certain winners, losers and opportunities are beginning to emerge. In addition, lessons can be learnt from the last time the market was at this low level.

Winners and losers?

OPEC has so far refused to cut its supply of oil in response to the falling prices. This has been viewed as an attempt by Saudi Arabia, using its influence over OPEC, to protect its market share. The drop in prices puts considerable pressure on competitors that use higher cost production methods, such as US shale production and deep water production. Saudi Arabia’s oil minister has stated that it does not intend to reduce its production even if the oil price falls significantly further. 

OPEC’s lack of response to falling prices does not advantage all OPEC members though. This is the case for those countries (eg, Nigeria and Venezuela) which are heavily dependent on oil revenue and do not have the large foreign currency reserves of Saudi Arabia and the United Arab Emirates. Nigeria has already taken the step of reducing its 2015 budget by $3 billion in response to falling market conditions.

Exploration and production companies and oil industry service providers have been hardest hit by low oil prices as companies attempt to cut spending. In such an environment where many are reducing expenditure there is likely to be less appetite for expansion, and may mean less cash is available for exploration drilling, new projects and re-investment.

In fact, recent analysis of various oilfields over which investment decisions are pending, suggests that nearly a $1 trillion worth of investment is at risk if prices remain low, as many challenging projects need the price to be at least $70 to be profitable. 

Opportunities?

Despite expected cuts throughout the oil industry, many have identified opportunities arising from the low oil prices. Businesses that invest in distressed companies are likely to become active in the oil sector as company valuations fall, and funds such as Blackstone and Apollo have recently established new energy investment funds and acknowledged the possibilities for them in the oil sector.   

While firms may initially be hesitant to initiate any large transactions while the price remains volatile, if prices stabilise at these low levels there is potential for significant restructuring in the industry. This has been a feature of previous periods of low oil price. Mergers and acquisitions allow for consolidation and will help companies cut costs while specific assets may become available at attractive prices to cash rich larger oil companies. If oil prices remain at this low level for an extended period of time many smaller oil companies will become vulnerable and the financial stress may make these attractive takeover targets. 

We may well therefore see an increase in asset sales, distressed M&A and strategic combinations in the oil and gas sector over the course of 2015. Repsol’s $8 billion acquisition of Talisman, announced at the end of last year, may be an indicator of the type of deal that will be common in 2015.

 

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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