Miro Lazarov
McGladrey Capital Markets
The size of the oil spill resulting from the Macondo well blowout and the inability of BP to contain the spill within a reasonable time frame will result in significant changes in the regulatory framework within which the oil and gas industry operates in the US.
The impact of these changes range from the immediate, such as the announced drilling moratorium, to the long-term with expected new environmental and safety regulations increasing the cost of exploration and production activities. This post-Macondo operational environment will require industry participants to reevaluate their strategies and change their course, if needed, to be better positioned for success within the new framework.
Business impact
The 6-month deepwater drilling moratorium announced in late May–which includes suspending action on the 33 deepwater wells in the Gulf of Mexico, canceling the proposed Virginia lease sale and the pending Western Gulf of Mexico lease sale, and delaying the planned offshore exploration in Alaska until 2011–will have an immediate impact on the industry.
Oilfield service providers with emphasis on deepwater drilling in the Gulf of Mexico, have seen their business come to a halt, while BP struggles to find a solution for the leaking well and the US government conducts its investigation into the incident. Large, diversified providers of oilfield services have implemented a strategic shift towards the shallow water Gulf of Mexico, onshore US drilling and international opportunities in offshore Brazil, offshore Africa, and Asia.
Halliburton Co., which has approximately 1,400 employees working in the deepwater Gulf of Mexico, announced in early June that it is currently in discussions with its customers to relocate a number of employees and drilling equipment in preparation for a long ban on deepwater drilling in the Gulf. Schlumberger also announced that it will look at redeploying Gulf of Mexico staff and equipment due to the uncertainty created by the US deepwater drilling moratorium.
In the long-term, we foresee that companies providing safety, monitoring and prevention, inspection, maintenance and repair services will be positively impacted as increased regulations will be implemented by the US government for offshore drilling. President Obama has already called for new safety measures aimed at offshore oil and gas drilling, including an overhaul of the testing, inspection and reporting requirements for blowout preventers and related backup and safety equipment as well as new design, installation, testing, operations, and training requirements relating to casing, cement or other elements of exploratory wells.
Upcoming regulations
In response to the demand for more regulation and a commitment from the US government to ending its cozy relationship with the oil companies, President Obama has called for a split of the Mineral Management Service, the federal agency that oversees offshore drilling, into three separate divisions (energy development, effective enforcement and revenue collection) with three independent missions. The Bureau of Safety and Environmental Enforcement will be tasked for ensuring comprehensive oversight, safety and environmental protection in all offshore energy activities.
We expect the Bureau of Safety and Environmental Enforcement to require the examination of all producing wells and prospects for any safety issues in an effort to avoid another BP oil spill, therefore creating a backlog of demand for the safety, monitoring and prevention, inspection, maintenance and repair services. The goal of the enforcement agency is to provide more transparency while holding energy companies responsible for their actions.
The Bureau of Ocean Energy Management will manage the issues regarding leases, planning and resource evaluation related to the renewable energy industry. The call for environmentally-friendly energy alternatives such as wind and solar, the continued legislative talk about rolling back oil industry tax breaks, and increased discussion from the US Department of Energy for the transition to clean energy will lead to heighten demand for renewable energy.
Furthermore, Obama recently called for further legislation to support clean energy in his first Oval Office address to the nation, while Senate Democrats are discussing three energy bills that aim to boost alternatives to fossil fuels such as oil and coal. With a dedicated bureau, the renewable energy industry will be able to act quicker and more decisively in an effort to advance clean energy development.
M&A and public markets impact
We have seen an immediate impact on the M&A and financial markets resulting from the BP oil spill. After a busy 1st quarter and good start to the 2nd quarter, in terms of M&A, the uncertainty in the market due to the spill has put the brakes (temporarily) on M&A activity in the oilfield services sector. The deepwater drilling moratorium has made it difficult for buyers to secure financing for transactions involving companies providing services that are directly affected by the deepwater Gulf of Mexico activity. Valuation multiples for offshore service providers have also been impacted due to the limited longer-term visibility of targets’ profitability.
In the first quarter of 2010, valuations were beginning to move up as a result of the lower oil prices volatility, improved outlook for the industry and increased debt availability. However, the uncertainty surrounding the BP spill has damaged investors’ confidence in the sector and the markets are in flux again, as demonstrated by the pubic markets. This volatility, combined with the uncertainty of the future of the industry, has created challenges for acquirers attempting to price transactions.
Figures 1 and 2 illustrate the historical public market performance for the large diversified and offshore-focused oilfield service companies. 
M&A outlook in the post-Macondo world
We anticipate that M&A activity in the oilfield services will accelerate again in the third and fourth quarter of 2010 as new regulatory framework takes shape and the industry activity outlook improves in visibility.
We expect that companies operating in the oilfield services industry will seek to reduce their risk profiles by expanding geographically and by diversifying their portfolio of services into other areas of the energy markets, besides oil and gas. For global players and these US companies with international aspirations, the most attractive companies are Brazil, Angola, Australia, Malaysia, and Russia. Domestic players will continue to focus on shale plays, where activity has been the busiest in 2010.
Oilfield service providers are also beginning to recognize the opportunity to leverage their expertise and expand into the high-growth renewable energy markets. We view the offshore and onshore wind and geothermal markets as the most attractive sector for oilfield service providers. Examples of such expansions include Wood Group’s transition from oilfield services into the onshore and offshore wind farm sector. Wood Group leveraged their technical expertise and supply chain to expand into the maintenance and repair, overhaul and upgrade of wind turbines.
Other offshore service companies, such as fabrication yards and specialty welding shops, are seeking for opportunities to emulate Wood Group and diversify into the offshore wind energy sector. Lastly, Schlumberger recently purchased GeothermEx Inc., a geothermal consulting service, to further strengthen their geothermal services division. Geothermal services will mitigate a portion of risk related to Schlumberger’s primary oil and gas functions. 
About the Author
Miro Lazarov's experience with McGladrey Capital Markets includes mergers and acquisition execution, recapitalizations and capital raises, primarily on behalf of clients in the energy and chemicals industries, among others. Prior to joining the firm, Lazarov was a senior analyst with Sanli, Pastore, & Hill. He earned a bachelor's degree from California State University, Northridge. He is a CFA charter holder and holds FINRA Series 7 and 63 securities licenses. He is fluent in Portuguese, Russian, and Bulgarian.
