International investments changing the US oil and gas sector
Charles Dewhurst and Clark Sackschewsky, BDO USA LLP, Houston
The United States' oil and gas sector has been on the upswing for about a decade. The shale revolution has continued to prove prosperous for the country's economy as demand soars and prices prove favorable, and there's no indication that the momentum will slow anytime soon. The US Energy Information Administration reports that natural gas production at new wells is outpacing declines in existing wells and that the US is now producing more oil than it is consuming.
This explosive growth is forcing a shift in the power dynamics associated with the global industry as a whole. US production of oil and gas has surpassed that of traditional power players like Saudi Arabia and Russia, and OPEC now expects that the United States and Canada could provide upwards of 4.9 billion barrels of oil a day by 2018.
This market reorientation is driving significant trends in the US transactions space. Though global merger and acquisition activity has remained relatively stable since 2007, the United States' share of overall transactions continues to comprise a majority of the M&A pie. At the same time, foreign investors are seeking to get a collective foot in the door of the US industry. International companies and individuals alike are seeing not only great investment opportunities in US shale, they are also seeing an opportunity to open an additional avenue to supply. These trends clearly emerged in 2012 and 2013 and are set to continue in 2014.
A look back
2012 saw an atypical jump in global M&A activity for the oil and gas industry. US energy industry research group PLS Inc. reported 679 deals totaling $254 billion, exceeding the previous record set in 2010 by about 20% and outpacing total deal value in 2011 by 50%. Nearly half of these transactions occurred among US companies, which saw 299 deals valued at about $83 billion, or about one-third of overall global deal value.
This burst of activity came about as companies across industries sought to close deals ahead of President Obama's second term, fearing that new regulations would hamper the deal environment. Additionally, 2012's results were skewed by major acquisitions by CNOOC, Rosneft, and Freeport-McMoRan Copper & Gold. Otherwise, the majority of 2012 deals fell in line with annual average values since 2007, according to PLS's data.
With this flurry of global activity closing 2012, 2013 appeared to get off to a slow start. PLS indicated that, in the first half of 2013, global deal count amounted to only 304 transactions totaling about $49 billion — the slowest pace seen since 2009 when the financial crisis eroded confidence and put the brakes on deal flow. Transactions did pick up slightly in the third quarter, which saw 150 deals close with a total value of about $42 billion. However, this pace was still not enough to match the deal flow and volume of 2012.
Despite this broader lack of momentum in global oil and gas transactions, the US energy sector remained active and profitable in 2013 and continued to see the lion's share of activity. PLS data indicated that the United States represented about half of all deals (in terms of both volume and flow) in the first half of 2013, recording 157 US deals valued at $22 billion. US deal flow continued in the third quarter, as well, posting 68 deals totaling approximately $12 billion.
Though 2013's final numbers are still being tabulated, the US energy industry appears to be managing expectations for 2014. From September through November 2013, BDO USA polled 100 US oil and gas CFOs about their predictions for the industry in the year ahead, including their thoughts on M&A activity and finances. According to our 2014 Energy Outlook, CFOs are quite optimistic about their finances for the year ahead — 71% feel better about their access to capital in 2014, up 20% from last year's study — but they are also moderating their expectations for deal flow.
Most CFOs anticipate that M&A activity will stabilize in 2014 with more than half projecting no change in deal flow and 43% expecting an increase. This contrasts with last year's projections, when 53% of CFOs expected to see a rise in M&A activity.
Overall, it appears that CFOs now view 2013 as something of a "reset" year after the torrid deal pace of 2012 and expect that 2014 will be more representative of the average deal flow seen over the past decade. Moreover, our survey results suggest that US oil and gas companies are not looking to pursue aggressive expansion policies in the year ahead. When asked how they plan to bolster profitability in 2014, one-third of CFOs cite improving internal business processes as a top tactic, while a mere 9% plan to pursue vertical integration through acquisitions.
Nearly one-in-four CFOs also expect to scale down their business: 12% plan to reduce exploration, while 11% cite staff cuts. In addition, a plurality (38%) say they will pursue cost reduction programs in an effort to increase value for stakeholders, a 58% jump from last year's study. These cost-cutting moves suggest that despite considerable growth, the energy industry is looking to right-size operations and become more nimble to manage potential future challenges.
International investment and industry right-sizing
At the heart of this right-sizing may be the growing prominence of foreign investment in the US oil and gas industry, much of which is occurring outside of the traditional M&A avenues. International investment is a mutually beneficial way for investors to reap the benefits of the United States' booming shale industry and for oil and gas companies to fund capital improvements, infrastructure build-out, and new projects.
International investors are looking to secure resources to address their countries' growing energy needs, and, thanks to the abundance of its shale, the United States is well-positioned to serve as supplier. According to our survey, CFOs predict that accelerated production of US resources will continue in 2014, with 73% expecting an increase in domestic natural gas supply, and 76% expecting the same for domestic oil supply. Accompanying this growth in supply is an attendant growth in demand: 65% and 64% of CFOs anticipate growth in global demand for oil and natural gas, respectively.
Asian countries have shown a particularly robust interest in investing in the US energy industry. As these countries' economies continue to experience exponential growth, demand for energy has risen as well. Many of these countries are seeking ways to accelerate their domestic energy production. For example, China is looking to tap into its vast shale reserves, while Japan, still recovering from 2011's Fukushima disaster, works to extract natural gas from methane hydrates in the Pacific. However, these efforts are time- and resource-intensive, so until these supplies come online, these countries will remain significant and reliable customers for the US energy industry.
Foreign entities appear less interested in acquiring US companies wholesale than in taking a stake in them. Joint ventures are growing in prominence, as they allow international investors (including national oil companies) to access the tremendous output of oil and gas from US companies without taking on the full scope of liabilities and risks associated with the industry – including an uncertain and challenging regulatory environment. In April 2013, the EIA found that US shale companies had entered into 21 joint ventures with international entities since 2008, suggesting that as shale production continues to grow, we may expect international joint ventures to do so, as well. Reuters news agency reports that China has already invested upwards of $5.5 billion in US natural gas assets, including Sinopec's $1 billion stake in the Mississippi Lime shale formation and Sinochem's $1.7 billion investment in the West Texas Wolfcamp shale. Similarly, Japanese utilities companies have shown interest in various US assets from upstream to downstream.
Foreign investors have also taken a keen interest in private equity as inroads to the US energy industry. Private equity research firm PitchBook found that between 2010 and 2013, US-based private equity funds active in the domestic oil and gas industry saw 295 commitments from limited partners, about 19% of which came from international investors. However, instead of seeking to secure supply, investors are using private equity as a relatively low-risk way to profit from a strong return on investment without taking on the operational challenges associated with acquiring a company or a joint venture. As a result, the number of foreign investors may be poised to increase in the coming year.
According to our survey, a considerable number of CFOs expect to look to private equity to fund their activities in the coming year: Though a plurality (45%) plan to pursue traditional debt financing for their cash flow needs, 40% say they will tap private equity investors.
The shale revolution has been a boon to the US economy, as well as to its efforts to become energy independent. However, as industry growth and profitability continue, it is clear that the benefits extend worldwide, not only to international investors, but also to consumers in need of energy to sustain growing economies.
The growing interest of foreign investors, whether they're national oil companies, private companies, or individual investors, underscores the significance of the US oil and gas sector to both the broader global energy industry and the international economy as a whole. The globalization of the US energy industry has been an important trend over the past few years, and it's one we hope to see continue in 2014.
About the authors
Charles Dewhurst is partner and leader of the Natural Resources practice at BDO USA LLP. Clark Sackschewsky is a partner with the Natural Resources practice. They can be reached at firstname.lastname@example.org and email@example.com, respectively.