Global upstream M&A deals to gain momentum for the rest of 2020?

Global oil and gas operators entered 2020 unaware of what the events in the first quarter will bring, including the extent and the aftermath of those events. As the Covid-19 pandemic decimated the global oil demand and drove oil prices down to new lows in early 2020, many players found themselves in an extremely difficult position. Some of those who barely managed to survive the previous downturn without filing for bankruptcy were not so lucky this time around.

The operators’ first response to the downturn was to reduce their costs well into 2021 and adapt their strategies to the new environment, but the prolonged economic recovery has left many knocking on bankruptcy’s door.

This means that, for some, consolidation may be the only way to stay solvent.

In this environment, consolidation of players makes sense in that it provides for a less fragmented market, enabling faster response to commodity price movements.

It also allows the bigger players with enough capital to take over the distressed, smaller players or their selected assets at a bargain price.

Andrew Dittmar, Senior M&A Analyst at Enverus, an oil and gas SaaS and data analytics company, said in early October: “There is a broad consensus that consolidation is a net positive for the industry”.

“Including the corporate deals from 2019, that process looks to be well underway. There is room for further mergers, but it can be a challenge to find the right asset and balance sheet fits for accretive deals. It may take several more years for consolidation to play out”.

Following the Covid-19 pandemic and the oil price collapse, the second quarter of the year saw a sharp drop in M&A activity.

Data by Finbrook – a provider of database products, research, and advisory services for the oil & gas sector – show that worldwide deal activity in 2Q 2020 fell by around 86 per cent relative to the three-year average for the second quarter.

The third quarter of the year was also slow, despite Chevron-Noble Energy deal, with a sharp drop in M&A&D activity in July 2020 as the negative impact of Covid-19 continued to be felt internationally and the activity remained depressed in August.

However, the numbers spiked in October, mostly driven by Cenovus acquisition of Husky Energy.

Following an increase in M&A activity in October, some believe that the remainder of the year may see the deal flow gaining momentum.

U.S. oil major Chevron has led the consolidation arising from the oil price crash and Covid-19 pandemic after announcing its takeover of independent producer Noble Energy in July 2020.

At the time of its announcement, the Chevron-Noble Energy merger was the biggest U.S. energy deal in 2020 and, according to Wood Mackenzie, the first large-scale corporate acquisition of this downturn.

Following approval by Noble Energy shareholders, the deal was completed in early October.

As a direct consequence of this merger, Chevron will reduce Noble Energy’s workforce by 25 per cent. This reduction comes on top of Chevron’s plan to reduce 10 to 15 per cent of its own work-force after the company promised to lower its operating expenses by $1 billion this year to cope with the downturn.

Back in July, we explored the possibility of Chevron’s acquisition of Noble Energy triggering a wave of M&A deals in the upstream sector.

Some of the main factors that influence M&A deals include capital, commodity price, and confidence.

While some argued that the upstream M&A activity would continue to nose-dive due to the lack of these factors, others claimed that, after the initial Covid-19 shock, the appetite for M&A deals would pick up as profitable opportunities arise due to incoming Chapter 11s and debt repayments.

According to Finbrook, about $14.6 B worth of deals were reported during July, but this number was mostly driven by Chevron-Noble deal.

Finbrook said in its monthly M&A&D report that only 53 deals were announced globally during Ju-ly, against an average deal count of ~67 deals per month during the first half of 2020, and an average of ~133 per month during H2 2019.

Other notable deals that month included ConocoPhillips’ purchase of B.C. Montney assets from Kelt Exploration for $405 million and Viaro Energy’s acquisition of North Sea operator RockRose Energy for ~GBP 247.6 million.

Another proposed deal was Lukoil’s purchase of Cairn’s interest in the RSSD Blocks offshore Senegal for $300 million, but this deal was later pre-empted by Woodside.

Come August 2020 and the global upstream M&A&D activity remained depressed with expectations for it to remain muted for the remainder of 3Q 2020 and the beginning of 4Q as the second wave of Covid-19 spread globally and commodity markets experienced further volatility in the period which led up to the U.S. presidential elections.

As the last quarter of the year started, new deals emerged and the global market saw an increase in M&A activity relative to the first three quarters. This was driven by big mergers in the U.S. and Canada markets.

Finbrook data show that $41.8 billion worth of deals were announced globally during October, with 44 deals being reported.

An all-stock merger between Cenovus Energy and Husky Energy accounted for about 40 per cent of the total deal value announced globally during the month.

Canadian oil and gas player Cenovus Energy made the move to combine with its compatriot Husky Energy in late October.

The two companies entered into a definitive arrangement agreement to combine in an all-stock transaction valued at C$23.6 billion ($18.01B), inclusive of debt.

When completed, the deal will create the third-largest Canadian oil and gas producer.

The combined company will have about 750,000 barrels of oil equivalent per day (BOE/d) of low-cost oil and natural gas production, including 50,000 BOE/d of high free funds flow generating off-shore Asia Pacific production.

Furthermore, the combined company expects $600 million in annual corporate and operating cost synergies, achieved through reductions to the combined workforce and corporate overhead costs including streamlined IT systems and procurement savings through economies of scale.

Namely, Cenovus Energy plans to cut between 20 and 25 per cent of its workforce after the acquisition of Husky Energy.

Other significant deals made in October include two Permian basin-focused transactions.

The first one was ConocoPhillips’ acquisition of Concho Resources valued at $9.7 billion and Pioneer Natural Resources’ acquisition of Parsley Energy in an all-stock transaction valued at approximately $4.5 billion. The total value for the transaction, inclusive of Parsley debt assumed by Pioneer, is approximately $7.6 billion.

When it comes to offshore, notable deals include Lundin Energy’s purchase of Idemitsu Petroleum’s interests in a portfolio of licences in the Barents Sea offshore Norway.

The transaction adds estimated net contingent resources of approximately 70 MMboe for a cash consideration of $125 million.

It gives Lundin Energy a 10 per cent working interest in the major, Equinor-operated Wisting oil discovery, scheduled to be one of the next Barents Sea production hubs, and a further 15 per cent working interest in the operated Alta oil discovery.

Another offshore deal worth mentioning here is Hess Corporation’s sale of its 28 per cent stake in the Shenzi field located in the U.S. Gulf of Mexico to BHP, the field’s operator, for a total consideration of $505 million.

The sale was completed in early November, bringing BHP’s working interest in the field to 72 per cent and adding approximately 11,000 barrels of oil equivalent per day of production (90 per cent oil).

Finbrook expects the deal flow to continue to gain momentum during the remainder of 2020, even as oil prices have dipped further.

“Majors will continue to seek opportunistic corporate and asset acquisitions, while the mid and small-cap juniors independents must sell assets or consolidate amongst themselves to survive in a protracted low oil price environment, as a second-wave of Covid-19 hits Europe and the U.S. over the winter”, Finbrook concluded.

“Regardless of the targeted play, mergers have so far focused on companies with reasonable debt loads”, Enverus’ Dittmar said.

“Companies with impaired balance sheets are being left to find their own way, resulting in a spate of Chapter 11 filings”, Dittmar added.

Enverus believes that there is potential for additional corporate deals for the remainder of 2020; however, the market for asset deals is likely to remain sluggish.

“Gas plays seem poised to draw more attention for asset acquisitions than their oilier counterparts as there is more optimism around the outlook for gas pricing”, Enverus said.

According to Enverus, a pickup in deal flow likely requires an uplift in commodity prices that boosts cash flow for existing participants, plus an inflow of new capital. Often private equity has deployed capital during down markets but looks less willing to step in currently.

Enverus suggests that one potential source of capital are Special Purpose Acquisitions Companies or SPACs. This model has been used before in oil and gas, most recently by Pure Acquisition Corp. which completed its previously announced deal during 3Q20 to form HighPeak Energy.

The data analytics company concluded that SPACs currently seem to be gaining broader acceptance in the investment community with rising use across industries.

Wood Mackenzie believes that consolidation among the independents will accelerate in the face of the energy transition.

Woodmac said that consolidation will be a defining theme over the coming decades. “Many of the most attractive Independents will combine, either as pure-plays with niche attributes at scale or diversified ‘mini-majors’ with growing carbon, capture, utilisation and storage, or renewables businesses”, Wood Mackenzie added.

According to Wood Mackenzie vice president, Luke Parker, the consolidation might already have started: “We may come to look back on the last few months as the beginning of the consolidation that will define the oil and gas sector over the coming decade and beyond”.