Merger & Acquisition challenges in Oil and Gas sector

The extreme volatility in the commodity market in recent months has ground global oil and gas Merger and Acquisitions (M&A) to a halt. With the exception of shale companies in the U.S.’ exploration and production sector, 2019 is unlikely to be marked as a promising period for M&A deals. The extreme fluctuation in prices witnessed in the third quarter of 2018 when Brent crude, which was trading at US$85 per barrel in October and later plummeted to $50 in late December, has put an extra burden on oil and gas companies to agree on the equitable value of assets.

With the decision of Saudi Arabia, the de-facto leader of OPEC, and Russia, the de-facto of non-OPEC producers, to restrain production levels to revamp oil prices, the U.S. has now become the world’s largest oil producer with its crude production rising to 11.7 million barrels per day. Although increased production has strengthened overall confidence, the incurring price volatility and the fall in oil stock prices, is likely to even negatively impact the U.S.’ recent M&As, not to mention those of other conventional petrostates.  

Comparative to recent years, and 2017 in particular, M&A deals in all segments of the oil and gas sector declined. The upstream sector, compared to the midstream and downstream sectors, has achieved better results albeit weak, but reports from the midstream and downstream sectors have not been very promising. Financial constraints, deteriorating market conditions, and price declines have all contributed to the weakness of global M&A in 2018.

This trend is set to continue and shape future M&A activities in the coming months. Over two-thirds of the largest volume of M&A activities took place in North America alone. The top two deals surpassed ten billion dollars. In October 2018, Andeavor’s acquisition of Marathon Petroleum Corp. to create the largest U.S. refiner by capacity and one of the top five largest refiners globally cost more than $35 billion while BP’s acquisition of BHP Billiton’s cost $10.5 billion. The U.S.- based Diamondback Energy bought rival shale producer company Energen at a cost of $9.2 billion.

Overall and globally, almost one-fourth of all deals took place in the U.S., dominated particularly by the upstream sector with approximately $80 billion worth of investments in 2018. Unsurprisingly, major U.S. deals mostly focused on the shale industry. 

Canadian M&A deals in 2018 were worth US$15.5 billion while the Middle East also experienced a relatively higher volume of M&A deals when compared with the rest of the world. The United Arab Emirates ranked first with the highest value of both national and international M&A deals at $8 billion.

Nonetheless, big international and national oil and gas companies, which have been involved in M&A activities for many years, will now face strong rivalry in the form of private equity firms and hedge funds that want to diversify their portfolios with energy investments, although their interest in the upstream sector has declined by 40 percent in 2018. Nonetheless, private equities are set to remain active players in M&A deals in the years to come relative to other sectors.

Private equity companies have focused more on the midstream sector through creative deal-making approaches by forming joint ventures. The acquisition of Devon Energy by Global Infrastructure Partners, the deal between Spectra and Brookfield Infrastructure Partners, and the acquisition of Basin by North Haven Infrastructure Partners are some of the recent examples of M&A deals that showcase the greater role that private equity firms are taking in M&As. Nonetheless, these transactions represent the fledgling entry of such firms and there is still room for growth.

Another factor to consider in the decline of such transactions is the rising interest in fostering carbon mitigation and in the participation in energy transition towards renewables to aid in fulfilling their corporate social responsibility goals. With greater concern over carbon intensity due to increased hydrocarbon production, many conventional hydrocarbon-based companies started to diversify their portfolios to mitigate carbon emissions in the long term by investing in renewables. It is even suggested that oil and gas companies experienced in offshore production could have competitive advantages with their many years of engineering expertise. These developments have all worked against the declining volume of M&A activities in the oil and gas field worldwide.

M&A activities in 2019 are likely to remain muted due to strong price volatility and with financing constraints that loom over the global economy. While debt financing and other alternatives options are alluring for many well-capitalized companies, carbon mitigation efforts together with diversified portfolio choices will continue to constrain the volume of M&A deals not only in 2019 but also in the years to come.

- Opinions expressed in this piece are the author’s own and do not necessarily reflect Anadolu Agency's editorial policy.