M&A in the Oil and Gas Sector
Although rarely grabbing headlines, the past few years have seen significant shifts in the mergers and acquisition activity of oil and gas companies. A sharp drop off in the first half of 2020 being followed by a strong rebound the second half of 2020 as debt became cheaper, bankruptcies created opportunity and consolidation plans were accelerated. This heightened activity has continued into 2021 although increasingly it is the environmental concerns of shareholders which are promoting strategic actions by major listed oil and gas companies.
Mergers and acquisitions in the oil and gas sector over the past few years have been driven largely by a desire to benefit from lower costs associated with gaining economies of scale. To fund these deals, firms have increasingly relied on debt to the point that between 2016 and 2020, debt was used to fund all but a few transactions. This led to an increasingly heavy debt burden on many companies in the sector and by 2020 this was having a material impact on the extent of deal making activity. However, the disruption of 2020 saw many companies in the sector becoming bankrupt with more than 100 firms in the sector entering Chapter 11 bankruptcies in America. These bankruptcies have allowed firms to significantly reduce their debt burdens and laying the foundations for a rebound in debt-driven M&A (also aided by low interest rates) in the latter half of 2020. This boost to activity is, however, likely to be short term with analyst firm Enverus predicting the effects of this will have subsided by the end of 2021.
In the medium and long term rising market interest rates and increasing pressure on institutions not to lend to fossil fuel projects will significantly increase the cost of debt finance. This may mean that private equity takes a more central role in M&A activity in the sector. However, there are signs that private equity firms are also concerned about the public perception of their investments in light of a greater focus on ESG. Difficulty in securing leverage will further dent their desire to enter the sector going forward.
Alongside its indirect effects via increasing financing difficulties, the increased focus on ESG is having direct effects on company strategies. In the past month Exxon Mobil lost in a battle with Engine No. 1, a little know activist investor, as the activist sought greater efforts to address the risks and opportunities posed by climate change. Also facing pressure relating to its address climate concerns is Royal Dutch Shell which recently received a court ruling in the Hague ordering it to set more ambitious targets for the decarbonization of its activities. As public companies such as these come under increased pressure to green their image, it is likely that they will accelerate a pivot toward renewables which some such as BP have already begun. This, along with large investments in ‘enabling technologies’ such as carbon capture and low carbon technology, will be offset by the continued sale of carbon intensive assets. Given the increasing pressure on public companies, it is likely that increasingly national oil champions will play an increasingly vital role in the M&A market as buyers for these assets, likely at discount prices. Therefore, the pivot in business models of significant numbers of publicly trades companies means activity in the oil and gas sector is likely to remain elevated although with a shift in the driver of this activity.
M&A activity in the oil and gas sector rose sharply to levels above those seen prior to the pandemic in the second half of 2020 following an exceptionally slow first half of 2020 due to virus uncertainty. The initial strength of this rebound was principally due to low interest rates and companies shedding debt via bankruptcy procedures. Furthermore, the low oil prices seen in 2020 accelerated firms’ efforts to gain economies of scale to remain competitive whilst there was an element of catch up due to deals being delayed by the initial Covid uncertainty. These drivers of oil and gas M&A are now subsiding but increased pressure from shareholders in many firms to accelerate the shift away from carbon intensive areas of the energy industry towards those which are less so is likely to continue to maintain elevated deal volume as firms off-load assets which no longer fit with their greener strategy and seek acquisitions to catch up in areas where such as renewables where they have fallen behind. Demand will likely hold up for these assets with high carbon intensity, albeit at a lower price, as firms not beholden to public shareholders, in particular national firms, seek to capitalize on the expected elevated oil prices in the medium term as investment in the sector falls.