American Oil and Gas Reporter - March 2016 - 41

SpecialReport: Market Analysis

Oil, Gas M&A Expected To Rise In 2016
HOUSTON-In contrast to 2015, upstream oil and gas deal activity will increase
this year, regardless of what happens to
oil prices, two market forecasters predict.
In its merger and acquisition outlook
for 2016, Wood Mackenzie says that, assuming oil prices recover as it forecasts
will happen later this year, companies
will move quickly to catch the next upcycle
and refocus from survival to growth.
Meanwhile, BDO USA LLP, in its eighth
annual Energy Outlook Survey, reports chief
financial officers at upstream oil and gas
companies predict a fire sale on distressed
assets this year as companies look to slim
down. Three-quarters of surveyed CFOs
think M&A activity will increase in 2016,
up from 56 percent last year, BDO reveals.
According to its survey, 85 percent of
CFOs see low oil and gas prices as their
greatest challenge in 2016. The energy
sector's increased pessimism about accessing capital and credit also may catalyze
deal activity in the months to come, BDO
indicates.
"Throughout 2015, we saw many M&A
players hesitant to engage in deal activity,
likely because sellers hoped the bust cycle
would balance out throughout the year,
and drive valuations up," poses Charles
Dewhurst, leader of the natural resources
practice at BDO. "However, as we enter
the new year, they are letting go of the
idea of rapid recovery, and may look to
sell before valuations bottom further."
Asset Sales
Wood Mackenzie says if commodity
prices remain low, it sees companies
being forced to sell assets and merge
businesses to free capital and cut costs.
"Uncertainty over oil prices continued
to drive a wedge between buyers and
sellers (last year), sustaining a slowdown
in activity that began in October 2014,"
says Luke Parker, corporate analysis director for Wood Mackenzie. "With longterm oil prices so fundamental to the success or failure of M&A, and costs still in
the process of resetting, most were reluctant
to commit to company-changing deals."
Whether oil prices move up, down, or
go nowhere in 2016, Parker predicts pressure to act will build on both buyers and
sellers. Exactly how the M&A market
recovers will depend on how oil prices
move this year, and where people expect
they will move beyond that, he offers.

Wood Mackenzie's analysis shows that
2015 was the slowest year for oil and gas
M&A in more than a decade. It says average monthly deal count fell by more
than a third, compared with the preceding
24 months. Excluding Royal Dutch Shell's
$82 billion takeover of BG Group PLC,
the analysis says deal spending collapsed
by two-thirds, and only 14 deals exceeding
$1 billion were announced. That compares
with 46 such deals in 2014, it adds.
"Should the pricing gloom persist, we
expect deal flow will increase in 2016,"
Parker says. "The drive behind deals, and
the types of deals we see, will differ this
year as potential sellers come under increasing
financial pressure. Mounting distress will
force more companies to market; balance
sheets will become ever-more stretched
without asset sales to balance the books."
Parker also warns that the number of
vulnerable companies is likely to increase.
While most of the top tier of international
oil companies can take actions to ride
out a year of low oil prices, the next tier
down may have fewer options.
Greig Aitken, principal M&A analyst
for Wood Mackenzie, says assuming oil
prices stay low, the company expects
more corporate consolidation and deals
that focus on cost cutting and operational
synergies. He adds the ability to drive
the pace of capital expenditures will be
crucial to companies that need to protect
their financial strength.
"Expect swaps and acquisitions based
on taking operatorship of assets," Aitken
says. "In some cases, controlling pace of
spending will not be sufficient. Living within
cash flow will be the priority for exploration
and production companies, and some capital-intensive development assets will have
to be sold, almost regardless of price."
According to Wood Mackenzie forecasts, the oil market will tighten in 2016,
boosting prices in the second half of the
year. It says this scenario will prove a
boon to M&A activity.
"As we saw in the second quarter of
2015, when sentiment takes hold that oil
prices are on the path to recovery, M&A
activity can pick up quickly,"Aikten assesses. "First-mover advantage is key-
securing deals before competition grows
and inflation sets in. At the moment,
companies are focused on survival, but
this could shift quickly back to growth in
a higher price environment."

In terms of likely buyers, Wood Mackenzie highlights the private equity sector as
being well-positioned for countercyclical
opportunities. Reports issued in 2015 suggested private equity funds had between
$40 billion and $100 billion earmarked
for oil and gas investments, it says.
Waiting For Turnaround
U.S. energy companies are taking steps
to streamline their operations as they wait
for prices to recover, BDO says in its
annual survey. Although M&A activity
was slower than expected in 2015, BDO
says deal pace has picked up, with companies such as Schlumberger and Shell
acquiring smaller rivals that were struggling
in a tumultuous pricing environment.
Just under half of the CFOs participating in BDO's poll believe undervalued
oil and gas assets will be the primary
driver of transactions as larger companies
and investors hone in on struggling companies seeking to shed distressed properties
and business units, the firm says.
According to the survey, as debt financing becomes more challenging, many
energy companies are increasing their
reliance on private equity. Fifty-five
percent of CFOs surveyed say they likely
will use that source for outside capital in
the coming year, up from 50 percent last
year and 40 percent in 2014. BDO adds
private equity firms view today's marketplace as an excellent opportunity to
deploy capital and pick up inexpensive
assets, expecting to reap the rewards
when oil prices rebound.
CFOs are rethinking company expenditures with commodity prices hovering
near record lows, BDO says. Only 1 percent of surveyed CFOs say they will be
increasing capital investment in offshore
exploration, down from 23 percent in
2015. Likewise, the number of CFOs
planning to increase investments in nonconventional plays dropped from 47 percent last year to a third.
In addition to cutting investments, oil
and gas companies are making tough decisions as contracting prices force them
to scrutinize labor costs, BDO points out.
Seventy-one percent of CFOs say they
hope to keep staffing levels consistent
with last year, while 9 percent indicate
they are likely to reduce their labor forces
to increase profitability. Only 1 percent
had those plans in 2015.
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MARCH 2016 41

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