Low oil prices to spur takeovers

As oil prices fall further, the list of beleaguered oil and natural gas companies vulnerable to take-over is growing. Ernst & Young’s Energy Centre says this signals the beginning of a new wave of consolidation. It expects oil and gas transaction activity to rebound as early as December 2009.

Big companies seem more likely to go for acquisitions to fill the gaps in their portfolios, as seen in the recent deals by BP and Statoil-Hydro to buy US gas assets from Chesapeake Energy. This has also been the model for Eni of Italy, which picked up Burren Energy in 2007 and First Calgary Petroleums in 2008.

Although large integrated oil companies, such as Exxon Mobil, Chevron and ConocoPhillips, have said that they are open to opportunities, they probably won’t buy companies or assets just because they look cheap. However, majors are going to buy companies or assets that fit into their long-term strategy.

The Achilles’ heel of major energy companies includes a declining production profile that could lead them to try to enlarge their presence in promising gasfields in US or to acquire companies with large undeveloped oil discoveries in oil-rich Africa.

However, the acquisition by an emerging market buyer last year has not been an entirely happy experience. ONGC Videsh (OVL) agreed its $2 billion bid for Imperial Energy last August, and the steep fall in share and commodity prices since then raised concerns that it was overpaying. Since ONGC announced this acquisition in August 2008, oil prices have fallen by two-thirds. This makes OVL poorer by $2 billion and could snowball into a corporate governance issue.

Some see struggling companies such as US natural gas producers Chesapeake Energy or Petrohawk Energy as possible acquisition targets. The market cap of these companies has shrunk as they suffered the consequences of having relied extensively on the capital markets. Fox-Davies Capital, the specialist oil and gas broker, says companies with over 100 million barrels of oil equivalent of commercial or near-commercial resources are the most likely acquisition targets. It cites JKX Oil and Gas, Regal Petroleum and Cadogan Petroleum, all of which are developing resources in Ukraine, as potential candidates.

Large, independent producers like Apache or Occidental Petro-leum are seen as more likely buyers of small struggling companies. Top executives of both companies recently said they were looking for acquisition opportunities.

For Bob Fryklund, vice-president of consultancy IHS, US-based majors could be interested in some domestic natural gas assets, but may have a greater interest in independent companies with large undeveloped discoveries outside the US. The list of these companies includes Verenex Energy, Tullow Oil and Kosmos Energy.
William Vereker, co-head of investment banking at Nomura, said the strategic rationale for consolidation in the oil and gas sector was compelling. “In 2009, we expect the pressure of falling prices and declining earnings to create the right conditions for mega-mergers as companies look to take costs out through synergies and rationalisation,” he said.
The five largest oil companies have a total of $82 billion in cash, while independents have about $10 billion and private companies have $15-$30 billion that could potentially be spent on acquisitions, according to Deloitte, the professional services group.
In addition to the fall in oil prices, the genesis of the coming wave of mergers and acquisitions lies in the rise of ‘resource nationalism’ in many countries, earlier aided by soaring oil and gas prices (which made them suddenly rich) and by plummeting oil and gas prices now (since falling oil prices have caused a major setback to their economies and they are keen to forfeit and lay their hands on whatever monies they have received), made it more difficult for international groups, particularly in the rapidly growing economies of China and India, to get access to oil and gas reserves they can develop for safeguarding their ‘energy security’.
During the 1960s, multinationals such as Exxon Mobil, British Petroleum and Shell controlled more than 80 per cent of global oil and natural gas reserves. Today, they control just 10 per cent, while state-run firms, according to a November 2007 paper from Rice University’s James A Baker III Institute for Public Policy, exercise exclusive domain over roughly 77 per cent.
There’s also the efficiency factor. In essence, western companies use the latest technology to reduce waste and maximise oilfield output. State-run firms tend to extract less oil and expend far more energy doing so. Despite vast deposits, oilfield production has been dropping in Mexico, Iran, Venezuela, and now even in Kazakhstan and Russia.
New ways to value international oil exploration and drilling companies need to be devised. Traditionally, the rate at which companies find new oil and gas to add to their reserves has been the valuation parameter adopted by most investors.
It is believed that oil majors such as Exxon Mobil, BP, Royal Dutch Shell and India's ONGC would have to change their business models to become more like service companies if they were to maintain their visibility on the world oil scene. As opposed to oil exploration and drilling, service companies working as specialist companies for national oil companies are accepted with open arms wherever they go.
Wealth creation for shareholders is the prime objective of any enterprise. A change in
business model of oil and gas exploration and production
companies in favour of oil and gas servicing activities is the need of the times. zz

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