As the oil price rout continues, mergers and acquisitions in the oil and gas industry are reaching near record levels, a recent report by Emirates NBD has found. The report estimates that close to $320bn worth of deals were signed over the first three quarters of 2015 alone.
Cutting cost and adding value were the main drivers behind the moves to consolidate, from chemical producers and refiners, to upstream operators and oilfield service providers.
So, with 2016 shaping up as another tough year for producers, that’s at least for its first half, is the M&A trend likely to continue?
“We certainly see signs that the scene is set for a robust round of M&A activity across the energy sector,” Dave Ernsberger, global editorial director at Platts told RPME.
“Asset values and share valuations are down at a time when many companies are still holding enough cash reserves to finance acquisitions in whole or in part. And as suppliers throughout the chain in the oil and petrochemicals markets adjust their strategies to cope with the fact that supply is generally overpowering demand, there is a strong desire to rationalise assets and drive usage of the most efficient units.
The most likely candidates for mergers and acquisitions, according to Ernsberger, will be companies that own both downstream and logistics assets such as storage facilities, pipeline infrastructure, terminals, etc.
“There are many privately-held and listed companies engaged in the supply and distribution of oil, refined products and petrochemicals, and many of these will be catching the eye of potentially cash-heavy suitors in the region and elsewhere,” he commented.
Across the board and among different business verticals, appetite for deals is strong and growing. According to PWC, over 50% of CEOs from the region’s oil & gas industry expect to enter into new alliances and joint ventures over the next year.
“Building scale in new areas that the region’s oil & gas sectors are aiming to develop, such as refining for example, will see them add to their domestic and global refining capabilities footprint. Building on these expanded capabilities to bring down costs will be a key area of focus,” Emirates NBD said in a recent report.
The geographic footprint for new energy investments has increased significantly. Meanwhile, energy firms in the region have shown renewed interest in foreign acquisitions as part of their long-term objectives to expand globally and diversify their assets. Last year, regional oil and gas heavyweights like Saudi Aramco, Kuwait Petroleum Company (KPC) and Qatar Petroleum (QP) purchased shares in downstream and upstream assets from rival producers in Europe, Asia and Latin America. Saudi Aramco, which has been an active investor in Asia, is reportedly in talks to acquire a stake in refining and retail assets owned by China’s state-owned oil company. “As China’ largest energy supplier Saudi Aramco is looking at cementing it’s foothold in China’s energy market across the value chain, the deal would represent a clear case of how Asia and GCC energy synergies work to create value,” Emirates NBD report said.
“Currently supplying almost 10-12% of China’s crude, Saudi Aramco’s efforts to capture refining and retail targets highlight the drive to be an energy provider across the chain from tanker shipment of oil to China to distribution in its regions and provinces,” it added.
Furthermore, the report suggests, a potential deal between Aramco and CNPC would provide a steady source of crude and address China’s growing domestic demand needs. As to Saudi Arabia, it would give it access to a stable and growing market for selling its crude at a time when rising global supply continues to put pressure on prices. The drive for acquisitions abroad is also the result of Saudi Arabia’s strategy to secure a hefty share of the global refining market, says Alan Gelder, vice president of research for refining and chemicals at energy consultancy Wood Mackenzie.
“When your strategy is to compete for a market share then it becomes logical for the upstream companies to be more interested in securing offtake through getting a greater exposure to refining.
“Now in Iran, and you can say Saudi Arabia as well, there has been a reasonable pick up in change of strategy through the declaration of wanting to keep a market share around participating in refining joint ventures in Asia.”
Gelder continued: “We are seeing greater interests in refining investments in Indonesia and China. The challenge for many of those is the timing around the [fact that the] development of refining projects take many years.
On the downstream side, Aramco has also been looking to invest in higher value products such as petrochemicals to support its longer term diversification objectives.
Furthermore, Emirates NBD predicts that acquiring stakes from IOCs which fall into the strategic objectives of local and regional producers will be another ongoing development in the region’s M&A scene.
To back up this claim, it gives as an example Kuwait Foreign Petroleum Exploration Company (KUFPEC) and its purchase of Royal Dutch Shell’s 8% stake in Australian LNG venture Wheatstone, further adding to its existing 7% stake.
According to KUFPEC, the acquisition will add 139mn barrels of oil equivalent helping meet its strategic reserves target. And adding 18,350 barrels per day equivalent of oil production. While deals of this kind are likely to continue in the coming months due to the indisputable value they add to regional operations of NOCs, the same would hardly be the case for acquisitions of downstream assets, as oil markets analyst Gaurav Sharma explains.
“We are unlikely to see an M&A splurge in the downstream sector, owing to a classic paradox created by the oil price fluctuation. Around the turn of the current decade, when the oil price started recovering from the slump caused by the global financial crisis, high risk or reward permutations returned with a vengeance for upstream oil and gas.”
“Subsequently, downstream assets found less favour among oil majors, especially in Europe, where refining and marketing businesses were losing money, facing tepid margins and were being squeezed by newer, more efficient state-owned refineries in the Middle East.
“Fast forward to the ongoing oil price slump, first signs of which surfaced in July 2014, and we see refining and petrochemical ends of the oil majors’ business contributing more meaningfully to corporate profits as the upstream end of their business struggles.
“Of course, assets would be up for grabs. However, I don’t expect the bid/ask differential to narrow considerably triggering a wave of asset sales. Sellers would be reluctant to sell at a time when the downstream end of their business is doing relatively well and would value the asset higher. At the same time, given wider challenges in the market, buyers would not like to pay over the odds either,” Sharma says.
China’s push to become a refining and petrochemical powerhouse, while reducing its reliance on the Middle East for refined petroleum products, could prove a major deal breaker to future M&As in the country.
“Evidence suggests existing Chinese facilities are running under capacity, so it is highly unlikely that China’s NOCs would embark on a downstream asset buying spree in the neighbourhood,” Sharma notes.
NOCs’ concerns over cash conservation at a time of lower oil price could further put a cap on short to mid-term investment.
“Not everyone’s approach would be the same, but anecdotal evidence suggests most would be frugal in their spending plans for 2016-17. Invariably, there will be a sale of distressed assets during the current slump. Some companies, especially in Europe, might well be forced to sell the family silver. This could potentially lower their asking price to a more realistic level that would find favour with potential buyers,” Sharma adds.
On the buying side, he is of the opinion that of the GCC countries, the UAE would be well positioned, especially in terms of its NOC’s integrated and R&M outfits (e.g. ENOC) to acquire tangible downstream assets from private sector players.
“Consolidation in leaner times is inevitable, which is why we have seen it across the spectrum from integrated to upstream companies, midstream operators to downstream players. Shell and BG Group, and Halliburton and Baker Hughes could be docked right alongside DuPont and Dow,” Sharma notes.
He continues: “That said, I classify these as big ticket M&A deals that we won’t have too many of in 2016. Furthermore, when it comes to downstream, the industry is littered with a history of spectacular one-offs that people thought would be a harbinger of trends and have proved to be anything but.”
Sharma maintains that an industry-wide buying spree is unlikely to occur in the coming 12 months and forecasts a “wait and see” approach by major oil and gas companies.
“If you look at the latest industry surveys from 2015, all point to an uptick in sector M&A activity last year compared to 2014. However, were it not for the three deals (Dow/DuPont, Shell/BG and Halliburton/Baker Hughes) the wider hydrocarbon and petrochemical world would be way down the pecking order.”
Even so, in a period of distressed oil prices, identifying investment opportunities both at home and abroad will remain key for GCC players. Faced with ambitious diversification plans and high GDP targets, companies in the region will need to take a long-term view to safeguard their position as global leaders in refining and petrochemicals and create value for their respective countries.
