What Happened to all the E&P Deal-Making?
One of last year’s big stories in the industry was consolidation among several of the larger upstream operators. But deal activity has fallen off in recent months. Will things remain this quiet during the somewhat uncertain year ahead?
One of last year’s big stories in the industry was consolidation among several of the larger upstream operators.
Firms such as BP, Concho Resources, Diamondback Energy, Encana, and Chesapeake Energy took advantage of consistently higher oil prices and added swaths of acreage in the most prospective and productive US onshore basins—in many cases doubling down on their positions in those basins.
Price stability is crucial for nurturing an active acquisition & divestiture (A&D) environment. After all, deals rely on the seller and buyer agreeing on the value of an asset. When prices take a sudden, unexpected dive as they did last fall, deal activity tends to slow.
“If the single biggest variable is oil and gas prices and that variable is jumping around, it's going to make it pretty hard to come up with a common number to do a deal,” explained Geoff Roberts, managing director and head of US A&D at BMO Capital Markets, during the SPE Gulf Coast Section’s recent A&D Symposium.
Looking at longer-term numbers from BMO, recent activity of around 60 deals/quarter pales in comparison with the 450 deals/quarter that took place in late-2016 and early-2017 as prices were moderating after the crash. That means for companies and investors currently looking to scoop up assets, there are far fewer assets to be had.
However, “I think we're going to see some improvement—so there's hope on the horizon,” Roberts said.
For the deals that have been getting done, he’s observed a few trends. Activity has revolved around assets that are oil-weighted and in well-defined core areas. There’s been small- and mid-cap consolidation as those firms try to remain competitive, and acreage trades have picked up as lateral lengths have increased.
Roberts expects to see a continuation throughout 2019 of operators “cleaning up” their portfolios. “If you look at the number of deals that have come out in this last 4 or 5 months, 95% of them are lower end, clean up assets.” Meanwhile, there’s just been a few “sizeable” deals valued at more than $100 million “that could serve as a core or substantial add on,” he said.
A “dominant theme” for the year will be BP’s plan to shed some of its excesses after its $10.5-billion purchase of BHP’s US onshore assets. In an effort to clean up its balance sheet, it’s now offering several packages for sale collectively called “Project Thrones.” Those packages are Swoop, East Texas, San Juan, Wamsutter, Arkoma, and Anadarko. But, “They're not looking for one large corporate buyer—they're looking for strategic buyers,” Roberts said.
Are the Public Markets Dead?
The widely-held belief that the “public markets are dead” is “pretty much true,” Roberts said, noting that the upstream space went 21 days without a high-yield issue last year. That hasn’t happened in more than 30 years, even with all the ups and downs in the market in between. Higher oil prices and market stability will help, but “mostly it's going to take a shift in how the upstream businesses do their job.”
“The old growth-at-any-cost model is absolutely dead,” he said. “Right now we’ve been in negative cash flow for years, and after a while the public markets just had enough.” Roberts quoted John Walker, EnerVest chief executive officer, who once said the upstream industry is adept at “destroying capital.” But companies have been working to turn the corner on free cash flow generation, and the markets have reacted favorably to recent earnings reports from the majors, ConocoPhillips, and Hess.
Further improvements will come as the engineers become even more proficient in drilling laterals, fracturing, and spacing, Roberts said.
“We’ve really got to get away from 300, 400 ft spacing,” he said. “We’ve got to spread it out a little bit. There's been a ton of work on parent-child spacing. The good news is it was in time to save most of us from drilling too many wells. The recovery factors are going up, and the costs are going down. And that'll keep happening.”
For now, investors want moderate growth, which “is tough” with crude prices in the mid-$50s/bbl, he said. “We really need 60-65 bucks for this industry to show a modest and moderate growth rate.”
Roberts noted that bigger is better when it comes to weathering the stock market storm. Over the past year, small cap firms lost 45% of their stock value while large caps lost 22% and majors lost 15%.
Private Equity “Paradigm Shift”
In the private equity (PE) arena, there’s a new focus that some are calling “a paradigm shift,” Roberts said.
There are some 500 PE-backed companies, of which 150 are in the Permian Basin alone. “There's a ton of money sitting on the sidelines,” he said. “But look at the competitive landscape. Look at the volatility and prices. The difficulty of finding deals.” Those seeking PE money may “have to find another model.”
The days of the “lease and flip” are “absolutely over,” he said. No longer can PE firms make a purchase and later sell the acreage for a loss or even small profit.
Time horizons are getting longer. “This is probably the fundamental change in what private equity backers are looking for,” Roberts said. “They're no longer expecting you to be in and out in 3 to 5 years.” Some are content with holding onto assets for 6–7 years, and some may even consider not exiting at all. It all depends on whether those PE-backed operators stay profitable.
“At Yorktown [Partners], their biggest and best investment was a company that they put money into 26 years ago and has never had a liquidation event,” he said. That company “simply generates cash flow day in and day out, year in year out. And, last I counted, they had received 12 times their initial investment back by just holding on to it.”
While Yorktown is a “slightly different breed,” Roberts said, other PE firms are starting to think that way too. “They could build a real company and just keep it. I mean, what a concept.”