Analysis: the anticipated wave of industry consolidation has not materialised.
Prices are right, so where are the oil and gas mergers?
When the prices of oil and gas assets fall to levels that allow producers to boost reserves more cheaply by buying them than drilling for them, it is usually a given that a wave of industry consolidation will soon follow. That is not so in this downturn. Despite the collapse in the market capitalisation of many publicly traded energy companies to below the market value of their untapped oil and gas, the anticipated wave of industry mergers and acquisitions has not materialised.
Instead, according to a study by the accounting firm PricewaterhouseCoopers (PWC), deal activity in the global oil and gas industry has followed crude prices "over a cliff". "Deal value reduced progressively throughout 2008," PWC reports. "Companies slammed on the brakes in the final quarter. "The immediate outlook for oil and gas deal-making in the early part of 2009 is bleak." Indeed, this year has been marked by an absence of any offers for oil and gas producers or their assets exceeding US$1 billion (Dh3.67bn). The richest bid so far has been a sweetened $650 million offer by the British gas company BG Group for the Australian coal-seam gas producer Pure Energy, after Royal Dutch Shell also made a bid for the company. Earlier this month, Shell said it would tender its existing minority holding in Pure Energy to the BG offer, making it likely that the bid would succeed.
Other proposed deals this quarter include a hostile bid, worth about $500m, by Total, the French energy group, for the Canadian oil sands company UTS. Britain's Dana Petroleum agreed to acquire Canada's Bow Valley Energy, a fellow North Sea oil producer, for about $177m, and China National Petroleum Company (CNPC) offered about $357m for Verenex Energy, a Canadian oil and gas producer operating in Libya.
By contrast, at least four major upstream oil and gas deals were proposed or concluded in the final three months of last year. In late October, BG agreed to buy Australia's Queensland Gas for about $2.9bn. In November, Norway's StatoilHydro agreed to pay $3.4bn for 32.5 per cent of the assets of the US gas producer Chesapeake Energy in the massive Marcellus shale gas reservoir. In December, China's Sinopec completed a $1.8bn acquisition of Tanganyika Oil, a Canadian oil producer operating in Egypt and Syria, and India's Oil and Natural Gas Corporation (ONGC) acquired Britain's Imperial Energy, which produces oil in Russia and Kazakhstan, for about $1.9bn.
In the previous quarter, while oil prices were near their peak, the deals were even bigger. Last September, the US oil and gas company ConocoPhillips agreed to pay $5.8bn for the reserves of the Australian coal seam gas producer Origin Energy, beating BG to that prize. In July, Shell also agreed to pay about $5.8bn for the oil and gas reserves of Duvernay Oil, a Canadian producer. Both bigger deals were for "unconventional resources that require considerable technological investment to access", PWC notes.
According to the firm's analysis, it is not so much the number of deals that has declined, but their value, which may not be surprising considering the drop of about 70 per cent in the price of crude oil since last July. Still, last year's average oil sector transaction size of $186.2m was 43 per cent below the 2007 average of $327.2m, despite the high crude prices prevailing through the first nine months of the year. That indicates a precipitous drop in asset valuations in the fourth quarter of last year.
"Deal value fell 59 per cent in the last three months of 2008 compared with the same period in 2007 and was 72 per cent down on the final quarter high of $95.5bn reached in 2006," PWC calculates. "Faced with unprecedented oil price deflation and uncertainty, even those companies who wanted to make deals struggled and, in many cases, failed to come to a common view on valuations." The difficulty of agreeing on a fair price for oil and gas assets is continuing to hamper deal-making this year. For instance, the board of UTS has rejected Total's offer, calling it "inadequate and opportunistic", even though production costs in the Canadian oil sands are such that the company may now be losing money on every barrel of oil it pumps. The UTS board has set out in search of a "white knight".
"We can do better for our shareholders," says the company's chairman, Dennis Sharp. That is not what happened in 1998, when oil prices plunged about 75 per cent, hitting $10 a barrel in December. Instead, the world's biggest private-sector oil companies rushed to embrace each other in an unprecedented series of mergers. At regulatory hearings before US and EU competition watchdogs, they argued that the low oil prices meant they needed to realise operational synergies and economies of scale to survive.
First out of the gate was Britain's BP, which in July 1998 proposed a $50bn stock transaction to acquire its US rival Amoco. In December, Total offered to acquire Belgium's PetroFina in a deal valuing the company close to $11bn. Eight months later, the merged entity proposed a second transaction to acquire France's Elf Aquitaine for stock valued at $54bn. In the US, meanwhile, Exxon in Dec 1998 proposed teaming up with Mobil through a record $82bn stock deal that created what is the world's biggest international oil company.
Today, the merged Exxon Mobil has a war chest containing 2.38 billion of its shares, with a market value of about $152bn, and about $40bn in cash. The company chairman and chief executive, Rex Tillerson, says Exxon Mobil will evaluate potential acquisitions. But if Mr Tillerson has a particular target in mind, he is keeping quiet about it. Instead, he has indicated Exxon Mobil may increase spending on its existing oil and gas operations by 20 per cent this year, to $30bn.
Analysts say the global financial crunch is holding back deal-making, and that a turnaround could happen quickly once credit constraints are lifted. "I don't think it is about the price of oil. It is about the price and availability of capital," says Dalton Garis, an assistant professor of economics at the Petroleum Institute in Abu Dhabi. "When the credit markets open up, they will go ahead and jump, because there are some real deals out there."
Analysts also suggest that international oil companies this year may focus on asset transactions to give a quick boost to output, rather than corporate acquisitions that would take longer to pay off. In this environment, producers are wary of spending cash they may need to stay afloat if crude prices take another turn for the worse, Dr Garis says. Marvin Odum, the president of Europe's biggest energy group, Shell, said earlier this month that the recession was creating opportunities to acquire oil and gas assets. The company is eyeing projects in Iraq and Russia, among other places, and plans capital spending this year of up to $32bn.
BP is also eyeing asset acquisitions, and last summer bought $3.65bn of shale gas assets from Chesapeake. But the state-owned oil companies of energy-consuming countries such as China and India, as well as the sovereign wealth funds of Gulf oil-producing states, could see value in acquiring well-run companies they would not have to manage. Britain's Tullow Oil, an Africa-focused energy firm that has made a large oil discovery in Uganda, has attracted the interest of Sinopec and CNPC, banking sources say.
The two Abu Dhabi companies with the task of investing part of the emirate's oil revenues in overseas energy ventures - International Petroleum Investment Company (IPIC) and Abu Dhabi National Energy Company, or Taqa - have not done any deals in the upstream energy sector since crude prices started to tumble. Taqa bought more than $6bn of international oil and gas-producing assets in 2007 and the first half of last year, but since then has focused on expanding its positions in gas storage and power generation.
IPIC, which historically has taken stakes in integrated petroleum enterprises, downstream oil and gas companies and petrochemicals firms, recently paid $1.7bn for a stake in a Papua New Guinea gas liquefaction project, and last month agreed to acquire the struggling Canadian chemicals producer Nova Chemicals for $2.3bn. But with the deals now on offer in the oil and gas production sector, IPIC may soon expand its investment horizons, an industry source close to the company says.