Will Chevron’s Noble Energy swoop trigger a wave of M&A deals in oil & gas sector?

A double whammy of the coronavirus pandemic and the oil price war from earlier this year has shaken the oil industry to the core changing its landscape for years to come.

In the aftermath of the oil price crisis, the second one in less than six years, and with the coronavirus pandemic showing no signs of slowing down, one must wonder about the direction of the upstream merger and acquisition (M&A) deals in the short and medium-term.

What will happen next in the upstream M&A and what direction will it take? Is now the time to go on the first buying spree after the COVID-19 outbreak and get the high-value goods at a bargain price?

Chevron might just agree following its surprise Monday announcement about a deal to buy Noble Energy thereby enhancing its position in the U.S. unconventional market.

The deal was dubbed the industry’s first major acquisition since the coronavirus pandemic triggered the market crisis.

The Financial Times said in early July that the big M&A deals had dried up and might not return for a while. The FT also said that the M&A would be confined to the bargain bin.

In the first half of the year, we saw a dramatic impact of the oil price collapse and the coronavirus crisis on the oil and gas sector. These events sent shock waves throughout the sector affecting big and small players alike, pushing them to revise and reduce their spending for this year and even the next.

As a result, we saw an inevitable reduction in the upstream M&A deals in the first half of the year.

The deal volume has collapsed, and the previously announced transactions have been re-negotiated, delayed, or cancelled.

When it comes to the overall environment for M&A activity, Enverus Senior M&A Analyst, Andrew Dittmar, commented: “Oil and gas M&A was already slow headed into 2020, and the worldwide COVID downturn slammed the brakes on any potential deals.

“However, it also created potential opportunities down the back half of the year and less than one month into Q3 we have our first major acquisition”.

A report by energy experts ERCE tracking global upstream M&A deals states that, while an overall number of deals in 1H 2020 stayed at similar levels compared to last year (1H 2019), the global deal value has dropped significantly.

According to ERCE’s latest report, there were only a handful of deals with a deal value exceeding $500 million.

In 1H 2020, the deal value average does not exceed about $2.6 Bn compared to 1H 2019 deal value average of about $14.7 Bn.

The top three regions with the greatest number of deals in H1/20 are APAC, North America, and Africa, ERCE reported.

Before Chevron’s announcement, the total deal value was $5 billion in the first half of 2020, compared to around $30 billion in the same period of 2019.

To get a better sense of the direction that the M&A deals might take in the period ahead, let us examine some of the factors that influence it.

Oil & Gas Council, an organization with a core mission to connect senior oil and gas executives with finances and investors, has recently hosted a webinar debating whether the upstream M&A will continue to nose-dive and whether the COVID-19 and the low oil price are the nails in the coffin of M&A.

Annant Shah, Vice President, Head of Capital Markets at Equinor, argued that unless capital, confidence, and commodity price stability returns, the upstream M&A activity will continue to nose-dive.

Following the oil price crash and the coronavirus pandemic, oil & gas players have slashed their budgets and headcounts and in this kind of a market environment, for Shah, the allocation of capital is key and the players are prioritizing funds towards exiting portfolios and domestic markets.

This is opposed to pursuing growth through acquisitions.

“Few have got the capital today and even fewer will prioritize that capital towards the M&A”, Shah noted.

He also noticed that, with large gaps in commodity price expectations, it becomes difficult to close any deals for both buyers and sellers.

There is a very wide outcome as to where the prices go from here, he said.

From the confidence aspect, as things stand today, the distress in the sector is likely to continue with Chapter 11s already started in the U.S. and this is perhaps only the tip of the iceberg.

Shah pointed out that the demand shock of this scale is new territory, and no one knows what recovery is going to look like. He did underline that some deals will take place, as they always do, but these deals will be highly selective, he emphasized.

Shah concluded that there is no capital confidence or commodity price stability to signal a proper step up in upstream M&A and, for this plane to actually come out of its nose-dive, it’s going to need a lot of jet fuel.

Eskil Jersing, Director at Eskoil Ltd., also underlined capital, commodity price, and confidence as the three factors that influence the M&A deals.

“COVID-19 has likely become the accelerant for the peak oil demand rather than a catalyst for change”, Jersing said.

In the next 18 months, Jersing expects that we will be in an E&P, carbon-based, free cashflow preservation mode and focused on asset divestiture rather than an M&A growth led one.

“Public market anaemia, dividend sustainability drivers, ESG oversight, and oil price uncertainty will all continue to strangle the overall deal flow ensuring that the priority of the companies in the public market space preserved the liquidity”.

Jersing emphasized that the timing of the transactions and execution is also critical.

According to Jersing, the deal value in 2018 was around $126 billion; in 2019 it was $87 billion.

It went from 88 deals to 65 in the U.S. and 182 to 105 internationally, so that is around 40 per cent below the five-year trend per Deloitte.

In 2020, the M&A deals have basically fallen off of a cliff and that was prior to COVID-19 in March.

Jersing agreed that the buyer universe has collapsed; few are cash-rich, the majority is focused on their own backyards and cleaning out debt mountains as a priority and chasing yield over growth.

“Nobody is buying”, Jersing said.

Going forward, Jersing believes that the landscape is likely to be smaller and simpler with the haves and the have nots and low growth, high fixed costs, low return world where limited cash is king.

“We’re not going to see forward global supply/demand clarity, I think, until at least fourth quarter this year and thereafter we’ll need a long period of price stability before M&A reverses out of its stall”.

“Upstream M&A will continue to nose-dive into a world of distress with limited buyers”, he concluded.

Clara Altobell, VP ESG and Business Innovation at Serica Energy, believes that opportunities are out there, there is money, and that creative deal structures are the way forward.

The fact that Eni, Shell, and BP have lowered their price forecasts and taken impairments has reduced the buyer-seller expectation gap and that does open the way to a lot of deals that may have been stalled, she said.

After the initial COVID-19 shock, Altobell thinks that now, the appetite for M&A deals is there and that it is going to pick up.

As companies change their strategies, opportunities become available. Altobell believes that Chapter 11s and debt repayments can be opportunities for companies and individuals that do have cash and they’ll step up and see that there is a profitable opportunity.

“We do still need to replace reserves unless there is a major shift in demand”, she said.

“I think we need a balanced approach. There will be deals and there are opportunities”.

Arguing that upstream M&A will pick up in the period ahead, Katya Zotova, Managing Director in Investment Banking for EMEA at Mizuho, said: “I’m a strong believer that we’re going to have a surge in the M&A activity”.

Zotova noted that this applies to the next 12 to 24 months period.

According to Zotova, there is a material price dislocation across the industry and that creates lucrative opportunities for those players with access to liquidity.

She also said that there has been massive underinvestment in exploration in the last five years.

Zotova noted that the oil and gas company’s stock is much more correlated to reserve replacement than it is to its profit. So, at some point, the investment world will demand the replacement of the reserves that are being depleted and there will be a push towards inorganic growth.

Just as Altobell, Zotova thinks there is money available for M&A and she also reminded of the possibility of stock for stock mergers, which don’t require capital.

She posited that the big chunk of the oil demand drive will return and probably stay with us for a while due to return in demand for plastic caused by the COVID-19.

“One of the big reasons for the low oil demand was because the plastic was being removed from the system and now, because of COVID, plastic is back on”.

Finally, Zotova said that there is a lot of private capital invested in the assets already that needs an exit.

There are divestment programs that are being announced by all majors so deal activity will continue and the question is who is going to be buying and it is a question of capital allocation for a lot of players as well.

“By capital allocation, I mean releasing and monetizing as many assets that are non-core to redeploy them into growth”, Zotova explained.

Following the end of the oil price war between Saudi Arabia and Russia in mid-April and the agreement to curtail the oil supply to balance the demand, which was destroyed by the COVID-19 pandemic, it is now safe to say that there has been some recovery in the sector.

One might expect this climate to be a catalyst for change that will push those that do have the capital to acquire high-value assets at a discount price and Chevron’s acquisition announcement on Monday might just be one of the first examples in the sector ever since the COVID-19 decimated the oil industry.

Just yesterday, Chevron revealed it has entered into a definitive agreement with Noble Energy to acquire all of its outstanding shares in an all-stock transaction valued at $5 billion, or $10.38 per share.

According to Reuters, this is the biggest U.S. energy deal this year.

The total enterprise value of the transaction, including debt, is $13 billion.

Chevron boasted that the deal will provide it with low-cost, proved reserves and attractive undeveloped resources. Through the acquisition, Chevron is bolstering its shale presence, as the oil price crisis has made the assets cheaper, and getting access to assets in Israel and West Africa.

Not to forget, this deal comes just over a year after Chevron decided to abandon its plan to buy Anadarko Corporation after being beaten by Occidental Petroleum’s superior offer.

Commenting on Chevron’s acquisition, Tom Ellacott, senior vice president, corporate analysis, at Wood Mackenzie, said: “This is the first large-scale corporate acquisition of this downturn.

“Chevron was our top pick to lead bottom-of-the-cycle corporate consolidation arising from the oil price collapse and the Covid-19 pandemic”.

Commenting on Chevron’s Noble Energy acquisition, Enverus’ Dittmar said: “This deal lays out the blueprint for what post-COVID consolidation will likely need to look like with all-stock consideration, a moderate premium, and asset fit and synergies that are an easy and natural story to tell investors“.

He added: “This could certainly ignite a wave of additional consolidation, although that is by no means certain as we saw with not many majors deals after the Anadarko takeover. While potential targets may be more plentiful, there aren’t that many companies with Chevron’s balance sheet strength and investor support to make up a buyer base”.

So the question remains, will the rest of the year see an uptick in M&A activity driven by distressed sales and opportunistic deals by better-positioned players and buyout investors or will the activity continue to nose-dive due to carefully executed capital discipline and cashflow preservation mode being implemented by the oil and gas players?

Adrian Lara, Senior Oil & Gas Analyst at GlobalData, a data and analytics company, offers his view: “Since the crash of oil price and demand in March 2020, there has been an increasing expectation for M&A activity to show existing opportunities despite the depressed economic cycle.

“Chevron’s $13bn acquisition of Noble Energy, including debt, is indeed the largest in 2020 and has an international diversification component, in both resource type and geography, which confirms that, besides healthy balance sheets, the most resilient companies during the pandemic have shown flexibility thanks to diversified portfolios.

“It signals the optimal future strategy for major oil and gas companies”.

Just as everything else in the year 2020, the outlook remains uncertain as the coronavirus crisis rages on affecting all facets of life as we know it and putting severe pressure on the oil demand while OPEC and allies are getting ready to loosen their production cuts implemented to help prop up the prices following the first COVID-19 shock early this year.

OPEC’s move was motivated by signs of demand recovery, but the oil cartel is still wary of the second wave of coronavirus, which could deepen the hit to demand to 11 million bpd this year. So far this year, the demand fall stands at around 9 million bpd.

While there have been signs of recovery in oil demand, whether Chevron’s billions of dollars worth acquisition of Noble Energy represents the beginning of an M&A surge and will other oil majors follow suit, it remains to be seen.