Mikaila Adams, Associate Editor, OGFJ
During the past 12 months we have seen a dramatic turnaround in the merger and acquisitions market. Deal count, total transaction value and acquisition prices have increased from the lows reached during the first half of 2009.
After two consecutive years of decline, global upstream merger and acquisition transaction value increased 40% in 2009 to just under $150 billion, according to energy research firm IHS Herold. Deals in North America, including ExxonMobil's $41 billion acquisition of XTO Energy and Suncor Energy's $21 billion merger with Petro-Canada, accounted for a record high two-thirds of the $150 billion.
OGFJ asked experts from various segments of the industry about their thoughts on both the current state of the upstream M&A market, primarily in North America, and how they see things playing out in 2010. Here are some of their answers.
Current state of M&A
The overall turn around in the M&A market can be attributed to the reopening of capital markets, market improvement, an increase in distressed transactions, and an improved commodity price outlook.
David Johnson of the M&A Group at Rivington Capital Advisors LLC noted that, "Banks are once again open for business," and that "private equity providers have started putting money to work and regained their focus on growing existing portfolio companies through acquisitions."
Chris Behrens, managing director of CCMP Capital Advisors, a private equity firm with offices in New York, Houston and London, offered his perspective. "On the private equity side, we certainly spent a lot of time in the 4th quarter of 2008 and the first part of 2009 talking to companies about their capital needs and accessing private equity as a way to give them some long term capital and flexibility for growth. For the most part, the volatility both in the capital markets and the commodity markets made it harder for buyers and sellers to meet in the middle. It feels better now given the strength in the debt financing markets, and I think, a little more stability in the overall system," he said.
|"We see a lot of our clients looking for oil whose philosophies have always been 'gas only.' They are switching to diversify during these times by drilling or acquiring oil." – Terri Williams, Meagher Energy Advisors|
Bid/ask spreads have narrowed in large part due to commodity prices trading in more predicable ranges during this period. "We've definitely seen the bid/ask spread narrow between the buyers and sellers. There's more stability coming into the market. Also, with the recession abating, the economy showing some signs of strength, and liquidity coming back into the markets, it's easier to get financing for some of these deals," noted Behrens' colleague, Karl Kurz, also a managing director at CCMP Capital.
Hugh D. Babowal, managing director of mergers and acquisitions for Wells Fargo Securities believes the bank lending market "remains quite good on a borrowing base loan basis, and so the ability, even through 2009, for companies to get acquisition financing was nowhere near as bad as it was for other energy companies–like midstream– or even general industrial companies. It's just a better financing market overall," he said.
The industry saw many highly levered E&P companies take advantage of improved market conditions and monetize assets to reduce debt. Adrian Goodisman, co-head of global oil and gas M&A&D advisor Scotia Waterous (USA), sees part the majority of the market in favor of sellers. "It's definitely a seller's market in general, but it's particularly a seller's market for any oil weighted assets and anything to do with the shales," he said. On the other hand, he noted, it is still a bit of a buyer's market on conventional gas, and that while deals are being done, prices have mixed things up a bit. "Prices are very low, so you think that you can pick some oil and gas assets up at a cheaper price, but the metrics haven't really come down so it's actually the opposite, they've [prices] actually gone up a little bit."
Another shift in thinking came in the number of transactions. "We were led to believe there was going to be a deluge of projects hit all at once with the capital constraints that we saw starting around October '08, but it didn't happen the way everyone predicted. Now we're hearing it again. Many are saying we're going to have a lot of assets hit during June and July that didn't make it to the market in the first quarter after reserve redeterminations," said Teri Williams, COO, of Denver-based Meagher Energy Advisors, who estimates the transactional advisory services firm has 12-14 projects "either on the market or in some stage of it currently."
|"Shale gas is real; it is here; it is valuable in a strategically organized business." – Jeff Barry, Warwick Advisors|
Rivington Capital's Johnson said a more bullish view on long term commodity prices by many E&P companies and capital providers has helped fuel the increased transaction forecast. It has also resulted in more competitive bidding.
According to Rivington Capital Advisors, since the second quarter of '08, acquisition costs have decreased by 20% and 23% when measured by proved reserves in the ground and producing units, respectively. Most of the experts agreed that valuations are landing closer to center.
Unlike other spaces within the energy world, noted Stephen Gallagher, who works in the mergers and acquisitions group at Wells Fargo Securities, the "E&P is a space where people are much closer on valuation. You're seeing gas transactions trade at the $11,000 or $12,000 per flowing Mcf and you're seeing oil transactions trade in the $90,000 to $100,000 per flowing barrel." He points out that the valuations have held for nearly two quarters, concluding that "both sides seem happy." "I don't think there's a driver for valuations to move up, especially on the gas side, and I don't think there's a lot of confidence in the oil side for the valuations to move up either, but there's kind of a happy medium right now where we'll see a lot of M&A activity."
Meagher Energy's Williams shared her thoughts, noting the firm has recently closed deals and received good numbers for the PDP component, but stated getting "full value" for PUD is harder now. "We are not seeing the values we did pre-October of '08 for acreage except for those unconventional areas such as the Marcellus, the Haynesville, the Bakken, Niobrara, Eagle Ford, etc.," she said.
The unconventional side of the industry, shale activity specifically–play activity, from drilling, to transactions, to the controversy surrounding hydraulic fracturing, was huge in 2009. Thus far in 2010, the horizontal rig count in the shales continues to rise. According to Smith International, shale rig count as of April 6, 2010 was up 231 or 83% from its '09 low, and the gas rig count now was up 294 or 44% from its '09 low.
"Shale gas is real; it is here; it is valuable in a strategically organized business," said Jeff Barry, director of Warwick Advisors, a Houston-based oil and gas capital consulting firm.
Shale activity seems poised to continue for various reasons. The technology continues to improve, for one. "It really continues to get better year over year as people crack the code in different shale basins. The economics there are so much better than in a lot of traditional oil and gas basins. I think it drives some companies towards the shale plays, and I think it will also drive M&A by having those companies that have a lot of opportunity to deploy capital in shale plays at high economic returns really divesting of conventional assets, and potentially midstream assets, as well," noted Gallagher of Wells Fargo.
While there are various trends within shale play activities, most in the industry recognize the significant impact this particular unconventional has played, and will continue to play, in the industry going forward.
Even within the shale plays there are emerging "winners." Right now, noted Babowal of Wells Fargo Securities, the Marcellus and Haynesville are big winners. "The Bakken, which is an oil shale play, is also considered a big winner."
While the Eagle Ford is emerging, there is speculation that it could be better economically than the Marcellus or the Haynesville, Babowal continued. "The real question is what's going to happen where the economics aren't quite as strong–like the Barnett, the Fayetteville, the Woodford, and some of the other potential emerging shale opportunities." "Even within shale plays you're seeing companies focus instead of on a portfolio of shale areas, on really one or two basins," he pointed out. "It will be interesting to see."
While excitement continues to swirl around the various shale plays, concerns about expiring leases and commodity prices linger.
Companies striking while the proverbial iron was hot and amassing shale play acreage since 2005 were more likely concerned with staking an immediate claim than dealing with expiring leases. According to Raymond James & Associates Inc., the typical primary lease term is 3-5 years. "To decrease their own capital risk and still hold acreage, a byproduct of this has been an increase in the number of joint-ventures formed over the past couple of years. The majors and international companies seeking to gain entry to and experience from the shale plays are paying top dollar to the independents that are more than willing to receive them," noted the company.
Enter the joint venture. The JV has been the "go to" transaction for many deals involving shale, and the experts expect it to continue.
|"It's definitely a seller's market in general, but it's particularly a seller's market for any oil weighted assets and anything to do with the shales." – Adrian Goodisman, Scotia Capital|
"It makes sense for both sides," said Williams of Meagher Energy. It works for the operators when drilling costs are so high. It's helping companies that are drilling on expiring acreage. On the other side, it's a way for these guys to get in that didn't get in on the land grab," she continued.
|"You're seeing a lot of guys continue to add rigs and drill in shales with a declining commodity price environment; I think they're going to struggle greatly to deliver the return that they need to make these things work." – Karl Kurz, CCMP Capital Advisors|
From Behrens' perspective, many of these transactions will continue to go towards the international companies. Companies like BP and Statoil "may be able to provide a lower cost of capital to develop those plays and may be able to absorb a lower commodity price environment for awhile better than private equity can," he noted.
Kurz, his CCMP colleague, commented on the influx of national oil companies coming into the domestic market. "The unconventional technology being utilized to develop all of this natural gas, whether it's in the Marcellus, Haynesville, Eagle Ford, or Woodford, is technology that can be applied in Europe and in other shale plays in the rest of the globe," he said. NOCs are coming into the market "to seek large reserve targets via the North American shale plays and unconventional plays," and "many companies are coming back to North America for the reduced political risk."
According to IHS Herold, "major oil companies and European IOCs invested heavily in US onshore shale gas through both asset and corporate acquisitions in 2009, lifting the percentage of global spending for the US to more than 40% of worldwide transaction value."
Warwick Advisors' Barry agrees that foreign companies will continue to invest in the North American market. "We have seen foreign companies building assets within the onshore American market, especially through joint ventures (farm-ins) and I believe this dollar re-deployment trend will continue, especially with shale gas assets and offshore Gulf of Mexico consolidation. Both are excellent training grounds for activities in other parts of the world along with producing profits," he said.
As pointed out by Scotia's Goodisman, the flow of international companies into North American shale transactions is occurring in waves. The first wave was the larger European companies. BP came in to do transactions with Chesapeake in the Fayetteville and Woodford, while Statoil struck its own deal with Chesapeake in the Marcellus. Additionally, BG worked a deal with Exco in the Haynesville, and France's Total drew up a deal to partner in the Barnett.
The second wave is being spearheaded by Asian companies. "Just recently you've seen two Asian companies do deals in the shales," said Goodisman. Sumitomo worked a small deal with Carrizo in the Barnett, and Mitsui worked a large deal in the Marcellus. Goodisman, who had just returned from Asia, said Scotia has put together many deals with international companies looking for opportunities in the US. "You've got a variety of Asian companies evaluating deals here and there in the US. I think that's the next group of people you'll see do more deals here."
The improvement in shale technology has brought many in, but will prices keep them there?
According to Raymond James & Associates Inc., the ever improving efficiencies of the shale plays made economic sense to drill at early-year gas strip prices ($6+). Many companies, when disclosing initial 2010 capex budgets, forecasted spending largely under the assumption that the slump in gas prices was only temporary and that prices were going to rebound in 2010. "On the surface, this made sense," noted the firm. "The 12-month futures strip was trading well over $5.50/Mcf throughout 3Q09 and above $6.00/Mcf by year-end. Additionally, companies locked in these relatively attractive prices by hedging production and locking in a large portion of cash flows."
Still, there is concern going forward. "I think the shales will disappoint depending on where the price deck ends up. With a good price deck we can make a lot of these plays work. There is a lot of excitement around them, but I do think you're going to need a $7-type gas price to make them work," noted CCMP's Kurz.
"That's one of the things that attracted us to Chaparral. While mostly oil, Chaparral has a lot of unconventional gas exposure to the Woodford Shale, the Granite Wash, and Cleveland sand, but unlike a lot of the players in the shale right now, their acreage is held by production. They don't have expiring leases and they can access and develop their acreage when the market prices deliver competitive rates of return," said Kurz of CCMP's recent $345 million investment in Oklahoma City-based Chaparral Energy Inc.
|"The real question is what's going to happen where the economics aren't quite as strong–like the Barnett, the Fayetteville, the Woodford, and some of the other potential emerging shale opportunities." – Hugh D. Babowal, Wells Fargo Securities|
Finally, said Kurz, "You're seeing a lot of guys continue to add rigs and drill in shales with a declining commodity price environment; I think they're going to struggle greatly to deliver the return that they need to make these things work."
While shale plays in general remain a target for M&A activity, the concern over the commodity price environment is steering some companies in the direction of oilier shale plays. The technology that made the Bakken work could be well-suited for developing the Niobrara in both the Denver Julesburg and Powder River basins, noted Jason Reimbold, a vice president in the Houston office of The Rodman Energy Group, in his April Analyze This column in OGFJ.
EOG's recent discovery well in Weld County, Colo. got the industry's attention. The Jake #2–01H with a 4,000' lateral resulting in an estimated IP rate of 1,700 bo/d producing from the Niobrara is just the tip of the iceberg.
Just before its merger agreement with Apache Energy, Mariner Energy Inc. completed an acquisition of 54,000 net acres in the Denver Julesburg Basin from an undisclosed third party, believing the Southern Wyoming acreage was on trend with commercial Niobrara shale discoveries.
Other players with significant Niobrara exposure include St. Mary Land and Exploration, Anadarko, Petroleum Development Corp., and Noble Energy. Other companies linked to the Niobrara include Rosetta Resources and Delta Petroleum. Even Chesapeake Energy has been tinkering in the Niobrara Powder River basin. Not long ago, the company known for its natural gas pursuits acquired oil shale assets from American Oil & Gas and North Finn LLC for $49 million.
"We see a lot of our clients looking for oil whose philosophies have always been "gas only," said Meagher's Williams. "They are switching to diversify during these times by drilling or acquiring oil. We're going to continue to see that," she continued.
For Scotia's Goodisman, who said he's "not too optimistic on seeing gas prices north of $6 per M," and sees oil going "to $100+," the trend goes beyond the shale plays.
"I think you're going to see more companies focus on oil period. You're already seeing that. You saw a transaction with SandRidge buying Arena, an oil weighted company. Aubrey McClendon talked about moving some of his rigs that were drilling for gas now drilling for oil. Oil prices are very strong. When you have gas prices sub $4, depending on which plays you're chasing after, the economics become much more challenging," he said.
Outlook for 2010
According to the aforementioned study, IHS Herold expects that relatively robust crude prices and a continued thawing of the credit markets will positively affect global deal activity in 2010, with more than $20 billion assets on the market and a pool of well-capitalized international buyers seeking to secure supply and grow reserves.
|"For the most part, the volatility both in the capital markets and the commodity markets made it harder for buyers and sellers to meet in the middle. It feels better now given the strength in the debt financing markets, and I think, a little more stability in the overall system." – Chris Behrens, CCMP Capital Advisors|
"Despite current soft gas prices, the massive volumes of long-lived North American unconventional gas resources with minimal exploratory risk are extremely enticing for IOCs that seek to replace declining production from mature, conventional basins," Chris Sheehan, IHS Herold director of M&A Research noted.
Warwick Advisors' Barry said to look for "new leading companies" as the shale gas business is set to "modernize managerial and operational thinking within the domestic exploration and production sector." He noted "as more capital is attracted to what are referred to as 'non-conventional' plays (mostly shale natural gas), the traditional 'conventional' company managers, and those financially associated with them, will have to develop a modern viewpoint or they will become marginalized over the long term," stating that while conventional domestic opportunities will still exist, obtaining capital may become more difficult.
He went on to say that "for modernization purposes or appearances 'conventional' companies will make an effort to acquire 'non-conventional' companies to obtain both the assets and, hopefully, the people who know how to optimize the acquisition," submitting the ExxonMobil/XTO acquisition as an example. "Whether or not such businesses can be integrated within existing traditional managerial systems to build value will remain an unanswered question," he said.
Goodisman predicts, in general, the industry will see many more asset transaction than corporate transactions. "I think you'll see more corporate deals than historically you've seen, but the market will still be largely driven by asset transactions and JV transactions."
"There's multi billion dollars in the market right now," he said, noting that Scotia Waterous was fortunate to have a part in many pending transactions, including one by ConocoPhillips, that was, at press time, yet to be announced.
To that end, it seems the general consensus is, like most things at the height of the recession, M&A activity was down, but not out. As things get moving once again, so, too, does the M&A market. Adapting to the times, M&A deals will continue to shape and reshape the industry.