Oil and gas prices have jumped to $100/bbl, but buyers continue to price acquisition offers as if oil was still selling for less than $50/bbl.
The number of mergers and acquisitions (M&A) in the US and globally remains fairly low, according to a recent Enverus quarterly report which said that only “the highest-quality inventory” is drawing interest.
“We chart those key (offer price) points at less than $45/bbl for oil wells and less than $2.25/Mcf for gas wells,” said Andrew Dittmar, director at Enverus Intelligence Research, who described the quarter as “modestly active.”
Discounts are the norm for M&A deals because oil and gas prices are so volatile. But the price gap between sellers and buyers widened earlier this year when oil surged above $100/bbl.
“The spike in commodity prices that followed Russia’s invasion of Ukraine temporarily stalled M&A as buyers and sellers disagreed on the value of assets,” he said. Activity picked up some in May and June for $12-billion worth of deals for the second quarter, compared to $14.7 billion for the first quarter, according to the energy data and consulting firm.
In comparison to other parts of the world, the pace of US M&A activity is strong. The $12-billion total in the US easily exceeds the total for Europe, Canada, and Africa. All other areas listed on the Enverus chart were zeroed out.
Most of the US sales were by private-equity (PE) investors, whose deals represented 80% of dollar volume. The buyers were generally publicly traded companies.
Those on both sides in these deals were affected by the low values put on the shares of oil companies reporting staggering profits over the past year.
PE owners need to seek out deals with investor-owned companies because initial public offerings are not an option in this market. On the other side, the buyers do not want to pay more than the value put by those trading their own stock.
“There is appetite on the public company side to buy out private E&Ps, but public companies need to keep the valuation paid on these deals in line, or less, than where the market is pricing their own stock,” Dittmar said.
Cost Inflation Pressure
Potential buyers can afford to be picky because they know that investors are focused on profits over growth.
“Buyers only want to pay for PDP (proved developed producing reserves),” Dittmar said, explaining that “if cost inflation and supply bottlenecks are going to limit your ability to turn new wells on-line, you don't have much incentive to go out and buy more inventory provided you aren't chronically short of locations.”
Those executives also know that $100/bbl oil is not the moneymaker it used to be for those working in shale plays.
The surge in the cost of services and supplies pushed the average oil price needed to justify drilling a new oil well in the Mid-Continent to $65/bbl, according to a survey of industry experts by the Federal Reserve Bank of Kansas City released on 8 July.
When they were asked what it would take to get them to substantially increase drilling, they put the number at $98/bbl, which was higher than the closing price for the WTI price in futures trading on 14 July.
The value of the US benchmark crude bounced back above $100/bbl on 18 July on news that suggested continued tight supplies of oil and strong demand for US gas.
The Kansas City Fed survey suggested steady US production growth. Those surveyed “expected slightly more modest growth for capital spending, profits, employment, wages, and benefits, and access to credit moving forward.”
One of the anonymous respondents summarized the result: “Historically, higher prices would usher in higher supplies and thus lower prices. External factors will prolong the cycle this time.”
Another said, “Prices will stay elevated due to little new investment in the search for reserves. Much of the expenditures have just replaced depleted reserves. Demand for fossil fuels will remain steady or even increase.”
Priced Out
The recent retreat by PE investors may be partly caused by those big investors dumping oil and gas investments for environmental reasons, Dittmar said. While PE firms that focus on energy investments remain active, he sees little interest from diversified global firms.
However, the timing of the sales is in line with past cycles where PE investors buy during oil downturns when assets are cheap, and then sell them a few years later when the business recovers.
This time the PE investors are negotiating for low prices with buyers to ensure they will be able to generate the large profit margins reflected in the Fed survey.
Cost inflation is one factor. But the wide gap between the breakeven to drill a well and the price needed to justify a large production gain is a sign to Dittmar for the need for profits high enough to sustain production and also fund payouts to investors.
“There is no more drilling for the sake of growth; every well needs to basically help fund the growing dividends,” he said.
