Mergers and acquisitions in oil and gas

1Mergers and Acquisitions in Oil and Gas

Mergers and Acquisitions in Oil and GasThe fall in oil prices will trigger a new wave of M&A in 2015


Turbulence in O&GRemember in 1998 when oil prices hovered around $20 a barrel and oil companies were flourishing? The severe price drop between then and the 1999 low of $10 a barrel ushered in a wave of mergers to gain economies of scale, creating the super majors of today: Exxon and Mobil in 1998; BP, Amoco, and ARCO in 1998 and 1999; Total, Petrofina, and Elf in 1999 and 2000; and then Chevron and Texaco in 2000.

Fast forward to the three years from 2011 to June 2014 when oil prices found a new level at around $110 per barrel with less volatility—some would say abnormally low—with the odd hiccup caused by geopolitics (see figure 1).

Many things have changed since 1998. Demand has shifted east, companies are finding and developing more challenging and higher cost fields, and most recently, the U.S.-led shale revolution and its stealthy, growing impact on supply has the United States now producing more than nine million barrels a day. Although oil prices rose by $90 per barrel, margins in the industry have not. So a >50 percent price drop now is likely to have a bigger impact than the drops in 1999 or 2008.

Costs have been high, and with the price of oil now under $50 a barrel in January 2015—and some betting it could fall below $40—pressure will be intense for industry leaders to have a clear M&A strategy. Several questions are key for the year ahead:

• How long will prices need to remain low before companies need to adjust to new realities?

• Will there be a new wave of mergers to capture scale or selective acquisitions to strengthen portfolios?

Henry Hub($ per mm BTU)

Brent($ per bbl)

Note: mm BTU is million metric British thermal units.

Sources: Bloomberg, December 2014; A.T. Kearney analysis

Figure 1 Oil price movements

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• When is the best time to move? How soon will the window close? Will early movers capture strategic advantage as the competitive landscape changes, or will more prudent fast-followers do better?

• Who has the strength to acquire, and who will be acquired? Are divestments a good option to provide needed cash flow over the coming quarters? Which criteria should guide the position and assets to sell?

Within this context, we performed a study to determine how the market might evolve and what impact market turbulence will have on different groups of companies (see sidebar: About the Study on page 16). Our findings suggest a business environment that is likely to present some angst as well as significant opportunities for those willing and able to adopt contrarian strategies.

M&A deals—whether acquiring, partnering, or divesting—will play a big role in shaping businesses to grow value and navigate the new, more turbulent landscape. The winners will be those firms that anticipate potential outcomes, choose how and when to act, and under-stand how these decisions will impact their positions and competitive dynamics.


Contents

Executive Summary 5

M&A in 2014 6

M&A Outlook for 2015 7

Outlook for Oil and Gas Sector Participants 8

Independents 9

International oil companies (IOCs) 13

National oil companies (NOCs) 15

Oil service companies 16

Financial investors 18

The New Competitive Landscape 19

About the Study 16



Executive SummaryMergers and acquisitions (M&A) in oil and gas showed a strong recovery in 2014 after a sluggish 2013, with North America remaining the most active region and upstream again being the most active sector. So what will drive M&A activity in 2015, and which companies will prosper?

Oil and gas supply has been building for some time driven primarily by U.S. shale, while geo- political challenges and escalating costs for more complex projects have made life difficult for producers. These factors have all contributed to an industry that is about to embark on a very challenging year. The recent plunge in oil prices, prompted by OPEC’s production decision, looks structural. This has triggered what is likely to be a new wave of M&A activity across the entire value chain. Those with strong cash flow and healthy balance sheets will have significant opportunities, while others will require new strategies just to survive.

The significant structural changes and sudden drop in oil prices in 1998 led to consolidation of the major international oil companies (IOCs). This time, industry executives are skeptical that such mega deals will be so prevalent when most have sufficient scale advantage. But never say never. In 2015, we expect many industry companies to be active in M&A as part of the response to margin squeezes and lower oil prices.

Independents. Balance-sheet strength and varying levels of exposure to assets with higher breakeven oil prices will determine the winners and losers as the margin squeeze takes hold. We also expect more adventurous financial investors to take the opportunity to enter.

International oil companies. Optimizing portfolios will continue to be the focus. Divestment of downstream and non-core assets could accelerate to enable funding of targeted upstream activity and meeting cash flow needs throughout 2015. Mega deals for scale synergy are not out of the question but will be limited, if at all. IOCs will favor selective acquisitions to build in their chosen areas.

National oil companies. M&A activity will be aligned with the national agenda of their host government, which is often strongly influenced by near-term domestic needs and politics as much as by economics and business strategies. Many have the financial strength to play a significant M&A role, and some are expected to be more active in 2015.

Oil service companies. These companies will continue to be hit hard as operator margins are squeezed and the pain is shared with service providers. There is significant potential for consolidation from mega deals through to the fragmented sub-segments. Financial investors with capital to invest will continue to be very active, plus new entrants with deeper pockets—such as large engineering companies—could make strategic moves.

Financial investors. There is plenty of capital looking to be invested in the industry, but the current margin squeeze, low oil prices, and sluggish demand could suppress some investors’ appetites. It will take confidence to capture the best opportunities. Investors will certainly acquire in the oil-field services sector, downstream divestments by IOCs, and for those still brave enough, some upstream assets beyond the traditional mature production.

For those with cash to invest, 2015 will offer great opportunities for countercyclical moves to buy attractive assets. Well-targeted acquisition strategies will provide stronger, higher value growth than the frontier and other previously planned expensive exploration. With debt pressures mounting and many independents’ share prices falling, some of these assets will be a good value. The window of opportunity may be smaller than expected, once oil price


expectations settle enough to bring buyers and sellers together. So now is the time to be clear on the best options to address the new industry outlook and dynamics.

A lot will happen in the year ahead. For some, the shakeout will be painful, but for those in the driver’s seat, it is a rare opportunity to reshape the competitive landscape to their advantage. The sands are shifting, and all companies will need to be clear on their strategies to thrive—or even to survive—in 2015.

M&A in 2014The 2014 M&A market showed strong recovery from a sluggish 2013, with year-to-date (January to November) deal volume of about 1,800 and deal value of around $440 billion already surpassing last year. The first half of 2014 showed signs of a rebound with total deal value rising 24 percent above the same six months in 2013. Many large deals (more than $10 billion) upstream, midstream, and downstream were announced during the year.

North America remained the most active region—with more than 65 percent of deal value in 2014 compared to 44 percent in 2013. This could be the result of companies’ efforts to restructure and streamline their portfolios and a stronger focus on U.S. shale. The Asian market also showed a rebound, with transaction value increasing by more than 65 percent from 2013.

Upstream remains the most active sector, with the value of deals rising 13 percent (see figure 2). Downstream deal value increased—by a striking 100 percent—as companies started addressing some longstanding portfolio issues. Midstream transaction volume dropped by around 30 percent, but deal value doubled, driven by a few large deals. The upstream sector has increased its domi- nance in deal volume, now representing more than 64 percent of oil and gas deals so far in 2014.

Transaction value by O&G target($ billion)

Sources: Dealogic and Thompson; A.T. Kearney analysis

Figure 2 Oil & Gas transactions by target sub-industry (2009-Nov 2014)

Transaction volume by O&G target(number of deals)

Downstream

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Oil service providers

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Despite the uptick in activities, deal volume was still about 25 percent below the 2012 peak. Asian and Caspian national oil companies (NOCs) and sovereign wealth funds have been the biggest buyers in recent years. The quieter buying activity since 2013 comes partly from these national companies being more focused on progressing and developing the big inventories of assets and positions they have already acquired as well as from lower returns since costs have escalated, even before oil prices fell.

M&A Outlook for 2015Oil price uncertainty could slow M&A in the near term, but then a new wave of deals will surface

Our discussions with industry executives confirm that recent oil price volatility will put the brakes on deals. When prices settle and valuation expectations between buyers and sellers converge, companies that already have short lists of what they want to buy will start moving to capture these key assets. Because deals tend to be under discussion and in the works for months, there will be a short lag before activity picks up again. Most companies are rapidly exploring how to address intense cost pressure, and M&A strategy is a crucial part of the solution for many.

“Oil price volatility will put a brake on deals until price settles… expect significant M&A activity as a response to sustained low oil prices.” —Industry executive

Plunging oil prices are creating both uncertainty and opportunities

By early January, oil prices had dropped by more than 50 percent from their stable range of $100 to $110 per barrel for the three years up to June 2014, with Brent prices falling below $50—levels last seen in 2009.

M&A transactions are propelled by industry dynamics. Plummeting oil prices caused by growing supply—most notably from shale producers in the United States and slowing demand in Asia and Europe—have changed these dynamics dramatically over the past few years. Lower oil prices are creating intense cost and cash-flow pressure. Participants across the industry know that a clear M&A strategy is a key part of the response needed to weather the storm and for the strongest to take advantage.

This creates opportunities. The price drop is unlikely to last forever, and opinions of how long this will last are sharply divided. One CEO said, “Buyers need to be brave and go countercyclical as the next 18 months will be fairly unique.” But buyers have become more cautious, even before the recent price drop. Companies are already trying to shed higher-cost assets in their portfolios.


U.S. exploration and production (E&P) companies, previously net buyers, have become net sellers of international positions as they focus on domestic shale. China’s NOCs have been busy digesting and getting more value from their surge of resource acquisitions over the past few years. Chinese companies bought 4 percent ($5.2 billion) of global assets in 2014, down from 17 percent ($24 billion) in 2013. Similarly, the value of assets acquired by companies from Asia was down 50 percent ($4.2 billion) in 2014 from what they spent in 2013.

Financial investors such as private equity and master limited partnerships have been particu-larly active in the United States, offering—against very low interest rates on deposits—a steady income at relatively low risk from producing assets. Some of these investors may get more cautious now that the value of these assets has fallen sharply and oil price volatility and risk perceptions have risen.

“Buyers need to be brave and go counter-cyclical as the next 18 months will be fairly unique.” —CEO, independent operator

The service sector and highly leveraged independents are likely to feel the impact of lower prices first. For the services sector, discretionary spending is already being cut. For two years or more, operators have lamented high costs eating into their margins—even with oil prices over $100 per barrel.

The market is undergoing tremendous change, driven in part by the rise of U.S. shale production. The focus on reducing costs will increase. Low demand and technology innovation will accelerate the progressive lowering of breakeven points, especially in U.S. shale basins. Financing, particularly for those with lower cash flow and higher debt, will become more difficult.

Today’s executives have to deal with more uncertainties and complexity. The new business environment is likely to present some great opportunities for those willing and able to adopt contrarian strategies. M&A deals—whether acquiring, partnering, or divesting—will be a vital way to grow value and navigate the new, more turbulent landscape.

The sands are shifting. Companies that best anticipate and prepare themselves to take advantage of the fast-moving and volatile situation—as the oil price finds a new balance point for supply in a more demand-constrained world—will be in a much stronger position than their peers. Those with a strong cash flow, healthy balance sheets, and the foresight to take first-mover advantage can make significant strategic gains in what will be a very dynamic competitive landscape.

Outlook for Oil and Gas Sector ParticipantsThe situation and potential strategies will look different for each group in the oil and gas industry. Figure 3 on pages 10 and 11 offers a condensed view of expected M&A trends, potential responses, and proposed actions for an array of companies. The following discusses each group in more detail:


Independents: much lower oil prices will cause a big shakeout for those with high costs and debt

Diverse in terms of size and focus, independents can be divided into three segments:

• Larger integrated independents: companies with upstream, midstream, and downstream production, with minimum 100 kboed production or 480 mmboe proven reserves1

• Smaller independents: E&P companies with more than 30 kboed production or more than 160 mmboe proven reserves, or both

• Unconventional-focused independents: companies that are mainly focused on unconven-tional resources (with unconventional assets covering more than 80 percent of production)

The total reported M&A activity for independents by deal value has grown year on year since 2012, with leading independents and unconventional-focused companies the most active companies in this sector (see figure 4). This picture is reversed when looking at the number of deals transacted.

The main driver behind the trend is the gradual reduction of larger integrated independents’ M&A activity over the past three years. Historically, the deals have been dominated by Lukoil, Mitsui, Inpex, Novatek, and Suncor as acquirers in up to 60 percent of the deals. In 2014, however, these buyers were largely absent from the market. This is primarily because of domestic political and economic factors with Russia and other producers, plus Japan facing currency devaluations and Russia’s sanctions that limit firms’ ability to do deals—at least for now.

By contrast, smaller independents have seen growth in M&A activities—primarily around shale positions. The most significant deals in this segment in 2014 were Encana’s purchase

Transaction volume


Figure 4 Independent M&A acquisition activities by quantity of deals and value

Transaction value($ billion)

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1 Kboed is thousand barrels of oil equivalent per day; mmboe is million barrels of oil equivalent


IndependentsNational oilcompanies (NOCs)

International oilcompanies (IOCs)

Source: A.T. Kearney analysis

Figure 3Analysis of di�erent situations and potential strategies by group

Recent M&Aactivities

• Some actively buying mature or marginal fields sold by IOCs

• U.S. E&Ps selling higher cost, more di�icult international positions to focus on North America shale plays

• Most deals continue to be in North America, with many smaller deals in Africa, Latin America, and Southeast Asia

• Increased focus on high-grading portfolios and growth through exploration

• Fewer, more targeted acquisitions

• Selling less profitable downstream and marginal assets

• Some companies have made significant progress in past two years, others less so

• China: Acquired many resources and capabilities up to 2013; pace slowed, became more selective

• Russia: Active deals within FSU and some high bids to gain international positions

• India: Still moving slowly, despite signaling interest in buying big resource positions

• Middle East: Limited focus on buying more upstream resources, but funds are available

Concerns andchallenges

• Cash flow is a big concern for operators with higher cost positions, especially given lower prices

• Funding and debt issues are paramount (plus stipulations and covenants on oil price hedges)

• Ideally, sell non-core assets, build cash reserves, put weaker projects on hold

• Continuing pressure from financial markets on free cash flow and dividends

• Cost inflation pressure; 8- to 16-month delays in complex developments and high-cost operations

• Di�erent operating model required to succeed in shale

• Little growth and thin margins even at $100+ oil prices of early 2014

• China: Focused on digesting and learning from previous acquisitions

• Russia: Under sanctions and in need of partners to provide capabilities and technology in Arctic and shale

• Middle East: Most not in need of more O&G resources; focused on diversifying and providing local jobs; costs are a concern for some

Anticipatedfuturesituation

• Possible distressed situations for weaker companies in a sustained low oil price environment

• Opportunity for independent operators with strong financial positions to acquire

• Cuts in capex; focus on cash flow and debt

• Some shale firms to dial down drilling until prices improve

• Shakeout may strengthen sector with stronger positions; ready for upturn

• More active portfolio high-grading, cutting capex, deferring high-cost marginal projects, and cutting long-term exploration to free up cash flow

• Focus on more profitable or higher value areas and less on pure volume metrics

• Focus on cash cost—own and suppliers’—to improve margins

• Larger companies already have enough scale and so unlikely to make major acquisitions

• Cost cuts (i.e., sta�) could hurt capabilities

• China: Will consolidate and learn from acquisitions. Seen as a potential contra-cyclical investor for companies in distressed situations with lower oil prices

• Russia: Currently hard hit. Eager to acquire—driven by need for technology and geopolitics

• India: Slow to the game and looking to catch up

• Middle East: Might seize on low prices; could control timing of window of opportunity

Proposedactions toconsider

• Larger operators: Put weaker and longer-term projects on hold before sunk costs rise

• Defer deepwater and frontier exploration; assess M&A options and impact on competitive strengths

• Smaller companies: Strengthen balance sheets, identify partners or investors (e.g., PE and NOCs)

• For both: Manage expectations

• Broaden scenario planning to include new range of oil pricing and competitor moves

• Pursue M&A where strength and robust margins are attainable

• Develop cost optimization strategies on high-graded portfolio; improve supplier management, standardization

• Move early; manage market, sta�, and stakeholderexpectations

• Reconsider partnerships and joint ventures

• Scan market for targets to match strategy and needs for capabilities or technology; distressed companies in need of funding could come calling

• Move early to ensure good timing

• Ensure delivery capabilities; reduce supplier costs


Oil service companies Financial investors

Recent M&Aactivities

• Diverse sub-segments, each with unique characteristics

• Oil field services (OFS) in particular characterized by a few large companies (two of which are now merging) and many small companies where investors (PE firms) are active

• Cases in which larger firms acquire smaller to capture key technologies and develop into viable products

• Technology and engineering firms expand into the market

• More funds focusing on energy (e.g., Blackstone, Vine Oil & Gas, Templar Energy)

• Historically focused on small- to mid-cap service companies but starting to buy into assets

Concerns and challenges

• Severe cost pressure from operators; quickly cutting back demand

• Lower asset utilization as projects are delayed or canceled; likely to first hit drillers and o�shore seismic companies with high fixed costs

• Companies with longer-term contracts in place may have more time to adjust

• Cost e�iciencies are needed, and soon

• Industry feedback of funds with capital struggling to identify and value suitable investments

• Appreciation of (and strategy to match) cyclical nature of industry and need for continual investment

• Oil price volatility might not fit the traditional financial investor model

Anticipatedfuturesituation

• Potential distressed situations for smaller, weaker service companies

• Selective acquisition by stronger companies (including technology and engineering service firms) to acquire niche technologies

• Potential consolidation of compa-nies, merging to increase scale, reduce costs, and improve negotiation position with operators

• Continued activities by financial investors; industry leaders note potential challenges of over-valued deals by financial investors

• Financial buyers interest in the oil and gas sector is expected to continue, with an increasing number of funds focused on energy

• Financial investors become alternative partners for weaker companies looking for funding

• Existing portfolio companies are dealing with similar challenges as other oil companies; cost pressure will be intense

Proposedactions toconsider

• Larger stronger service companies: Get proactive about M&A; use merger scenarios to discern com-petitive impact; maintain strong cash flow and balance sheets; evaluate new business opportunities

• Smaller, weaker service companies: Stress test balance sheet and identify partners or investors

• Financial owners: Focus on scenario planning, cash position, and cost reduction to match demand

• Review current portfolio of investments with scenario planning

• Perform market scan of potential targets; distressed companies in need of funding could come calling

• Secure skilled personnel and guidance to help navigate the oil and gas market

• Identify core areas of focus

Source: A.T. Kearney analysis


of significant shale assets in the Permian and Eagle Ford basins.2 Southwestern has also been very active, purchasing $5.5 billion of Southern Marcellus Shale and Eastern Utica Shale assets from Chesapeake. These follow on the heels of the $6 billion acquisition of GeoSouthern Energy Corp by Devon Energy in 2013 and suggest that independents could continue to pursue scale in the basins where they operate.

Some shale companies may rapidly dial down drilling activity, as they can in a matter of weeks, and then are likely to crank drilling and production right back up again just as fast when prices improve.

However, not all is rosy in the independent sector. Some firms are sitting on what were marginally profitable fields at $90 to $100 per barrel, having heavily invested and expanded during the boom years. These companies may now start to look vulnerable and be seen as acquisition targets (see figure 5).

In a sustained low oil price scenario, these companies will likely look to offload some of their high-cost assets—if they can—to rebalance their portfolios. Such assets may prove attractive for firms with differentiated capabilities or a technology edge enabling lower production costs.

Two factors will drive independent M&A activity. First, we will see a continued drive for growth and scale, in particular for basins to create scale—driving down costs and jockeying for position

1 Encana’s $6 billion to $7 billion purchase of Athlon was still to be completed when this paper was written. The Eagle Ford acquisition was a $3.1 billion asset purchase from an E&P company.

Less vulnerable tosustained low oil prices

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1 Contact authors for more details about independent companies2 Reserves as defined by Rystad at P90—the low estimate of the remaining recoverable volumes

Sources: Rystad Energy; A.T. Kearney analysis

Figure 5 Independents’ reserve profiles1,2

More vulnerable tosustained low oil prices

Larger integrated independentsSmaller independentsUnconventional focused companies(unconventional assets >80% of production)

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to generate better returns. Second, independents with a significant percentage of high breakeven assets, lower capital, and dividend cover and higher levels of debt—especially where debt covenants include oil price hedges that are maturing over the next few months—could end up in distressed situations (see figure 6).

The diversity of portfolio and financial strengths in the independent segment means the M&A strategies will be diverse. The winners will be those with the cash flow and balance sheet strength to take early action on portfolio high grading—either selling production to de-risk the low oil price or taking advantage of the situation to capture bargains as weaker competitors struggle.

International oil companies: stronger focus on costs and portfolio high grading

IOCs have been making fewer acquisitions since 2010 (see figure 7 on page 14). At the same time, IOC divestments have increased, especially in marginal fields and downstream assets such as refining, retail stations, and chemicals.

IOCs have been reviewing their portfolios to determine where to focus to maximize their chosen set of success metrics and to maximize shareholder value.

While reserve replacement ratios, economies of scale, and entry into unconventionals were stated as the drivers of acquisitions in the past, industry leaders indicate future moves will be to refocus their portfolios. This is also observed in many IOCs’ emphasis on free cash flow and dividend payment in their strategy and financial reports to the market.

Sources: Rystad Energy, Bloomberg; A.T. Kearney analysis

Figure 6 Independents’ capital and dividend cover ratio vs. debt/equity (%)

20% to 30% resources with breakeven oil price > $80/bbl

>30% resources with breakeven oil price > $80/bbl

Size of bubble represents relative 2013 revenues

10% to 20% resources with breakeven oil price > $80/bbl

<10% resources with breakeven oil price > $80/bbl

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In recent years, IOCs have used prices down to $80 per barrel in scenarios to sanction projects. With strong balance sheets, downstream as a counterbalance, and scale, IOCs are likely to weather the oil price plunge by cutting near-term capex, reducing costs, and focusing on a smaller set of upstream projects. They may sell or mothball some assets to free up cash.

Falling oil prices will cut activity and shift the focus to lowering breakeven prices (see figure 8). As capital spending declines, service companies will lower pricing to maintain utilization.

1 Excludes non-O&G related deals purchased by O&G companies


Figure 7 Leading IOC acquisitions since 2010 ($ billion)1

Exxon Mobil Corporation

BP plc

Royal Dutch Shell plc

Chevron Corporation

Total S.A.

Eni S.p.A.

ConocoPhillips

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Region or fieldRegion or field Average breakeven price, June 2014

Sources: Rystad Energy; A.T. Kearney analysis

Figure 8Breakeven prices by type of fields

Arctic region $78/bbl

Oil sands $74/bbl

North America shale $62/bbl

Ultra Deepwater $57/bbl

Onshore Russia $54/bbl

Deepwater $53/bbl

O shore shelf $43/bbl

O shore Middle East $29/bbl

Average breakeven price is expected to change as industry responds to cost pressure and low utilization.


The economics for different basins will change. Operators have already got breakeven prices down to $30 per barrel for some parts of south Texas, while Bakken may need closer to $50.

Our experience with many IOCs confirms their increasing focus on improving cash and reducing costs, typically via standardization and efficiency exercises—even before the oil price decline. With the vast majority of costs sitting in the IOC suppliers, it is now crucial that IOCs develop leading capabilities in procurement and supply chain to address the intense cost challenge in a sustainable way. This will impact consolidation in the service sector and, as best practices from other industries are adopted, will also drive the need for deeper, more strategic relationships with oil-field service companies and engineering, procurement, and construction firms.

New technologies have the potential to unlock existing and new reserves at attractive economics. We explored with IOCs if they should acquire or in-source service companies for technology or capabilities as part of building cost advantage or differentiated capabilities to take to joint ventures. This drew an interesting and diverging debate. “Buying companies for exploration skill doesn’t work as the talent just walks,” one CEO said. Another had a more positive position, saying, “People consistently underestimate the value of technology.” For most executives, it was not an area much considered, mainly because of integration risks. Many noted this could be a new avenue to consider in establishing competitive advantage, especially in areas that add to their technical capabilities in exploration and frontier fields.

Regardless of improving economics, the need to meet dividend and capex commitments will accelerate divestment programs in IOCs. Some felt that, given depressed oil prices, this may favor a more aggressive downstream divestment agenda, where asset values are less impacted by low oil prices.

Any acquisitions are likely to be opportunistic if valuations decline in a sustained low oil price scenario and could extend to buying service companies to supplement strategies and any technology gaps.

Most IOCs already have an M&A strategy mapped out. The focus on cost reduction, divestments, and meeting shareholders’ near-term expectations is making it more challenging for major IOC acquisitions, but the stronger positioned will undoubtedly take advantage of the buyers’ market. Executives were skeptical about another round of IOC mega mergers in response to low oil prices and cost pressure—but never say never.

National oil companies: pace of investment will slow and depend on host government agendas

While IOCs have retreated as buyers from the M&A market since 2010, NOC activities increased with some major deals in recent years (for example, Rosneft-TNK in 2013). The Chinese were especially active in international deals before 2013, while Middle Eastern, Indian, and Russian NOCs remained absent from international acquisitions (with the Russians focused mainly on the former Soviet Union).

The dynamics for NOCs are understandably different than for other oil companies—acquisition rationales range from energy security and internationalizing outside their home country to geopolitics and acquiring capabilities or technology know-how—with some more constrained by having to help their government balance their books.


Looking forward, expected M&A trends for NOCs vary by region and type:

China. Acquisition of resources is likely to be more careful and considered as NOCs learn from previous acquisitions. If oil prices stay low, good opportunities to acquire more needed resources are likely, especially in situations where they could be invited as potential investors or partners to alleviate distressed situations or where geopolitics prove to be a barrier for other investors.

Russia. Deals are governed in large part by geopolitics. Russian NOCs very much need technology know-how to develop their Arctic and shale, but investments from Western companies are now hampered by sanctions. Cross-border acquisitions outside Russia, especially downstream, were also seen as options for Russian NOCs to extend their sphere of influence.

India. These companies remain behind other NOCs in international acquisitions, but they could start buying, especially in a sustained low oil price scenario. Some have publicly indicated their intention to buy the resources they need, but real moves must overcome bureaucratic and other internal hurdles.

Middle East. With their own strong resource base, these NOCs have not been active buyers of upstream positions, preferring to buy and grow capabilities in other industrial sectors. (In 2014, Saudi Aramco acquired a stake in S-Oil, a downstream firm in Korea.) Perhaps with their strong cash positions and potentially good opportunities at low cost while oil prices remain low, more may venture to take international positions, as Mubadala, Kufpec, and Kuwait Energy Company have done.

Many NOCs have enough cash to take a significant role as buyers in the expected new wave of M&A, especially if oil prices stay low. This would be a good time for them to reassess their strategies to be ready for proactive moves that fit their remit and government objectives. The window of opportunity will not last forever. Will NOCs move fast enough to take advantage of the situation?

Oil service companies: an intense focus on reducing costs will drive consolidation

Total reported M&A activity in the oil service sector slowed between 2012 and 2013. Then in 2014, deal value increased dramatically, especially with the $35 billion Halliburton and Baker Hughes merger announcement. The sector is extremely diverse with multiple sub-segments, from

About the Study

To understand how the market could evolve and its drivers, we talked with more than 30 senior executives across the globe, spanning the entire value chain from the oil majors, national oil companies, and leading indepen-dents to service companies and financial investors.

Our analysis includes all M&A in the oil and gas industry from 2003 to November 2014, with utilities classified by SIC codes. The following transactions are not included in our analysis:

• Deals where both partners or their parent companies are not in the oil and gas industry

• Deals that were classified by Dealogic as a buyback

• Deals announced outside of the analysis period

Most transactions are displayed on an annual basis. Unless otherwise stated, transactions are captured by date of announcement rather than date of completion as this is closer to when they were negotiated.

Dealogic is the main source of all M&A data; Thompson is the secondary source. Rystad Energy is the source for all reserves and production-related data and also helped classify independents. SIC- code categories are based on the U.S. Department of Labor’s Occupational Safety and Health Administration.


seismic, drilling, development, oil-field services, and IT to suppliers of consumables, logistics and transport, and engineering, procurement, and construction. Each has its own set of charac-teristics and drivers.

“…the oil and gas service sector is at the start of a major restructuring…full of opportunity and risks!” —Oil field service provider

The oil-field services sector has often been described as an hourglass with the top three firms dominating with around 40 percent market share and a multitude of small firms making up the rest. Financial investors such as private equity firms have been active acquirers. Over time, financial investors have taken a bigger role. In 2014, reported deal values for financial investors were the highest in more than three years (see figure 9).

As operators look to manage cash flow with lower oil prices, many prospects, projects, and fields could quickly become uneconomic and be delayed or stopped entirely. Pressure to lower rates is being passed directly on to service companies, which face lower utilization of rigs, vessels, and crews. Operators expect their suppliers to share the pain, and competition for business will intensify, especially in regions where breakeven margins are thin. This will hit drillers and offshore seismic companies (with high fixed costs) first. Others with longer-term contracts will have a little more time to adjust, but not much—perhaps only a few months.

OFS

257

24%

246

20132012

43%

Financial

Others

33%

45%

31%

25% 25%

2011

293

30%

Oil service company OFS M&A transactions by acquirer(deal volume)


Figure 9 Oil field services (OFS) deal volume and value

2014

YTD Nov

2012 2013

293

257246

34 32

72 Deal volume

Deal value($bn)

44%


A.T. Kearney’s recent engagement as a partner with the World Economic Forum looked closely at unlocking the full potential of oil-field services. This work shows that the sector is ready to take action to address the key challenges to deliver lower costs and better returns on capital invest-ments. However well the sector responds, we expect significant M&A activity in at least two ways:

Smaller oil service companies as targets. Valuations will decline. Companies that are more vulnerable (such as those with cash flow or funding difficulties) will be considered potentially attractive targets depending on what they offer. Buyers are likely to be large, well-positioned oil service companies and non-traditional industry participants such as engineering services firms looking to expand their portfolios. Financial investors are expected to be active, although some industry observers point out that some companies with potential liquidity issues are already owned by private equity.

Larger oil service companies as buyers with merger potential. Stronger and larger companies will look to capitalize on more favorable implied valuations to further strengthen market share or become fuller service providers and thus be better able to address the cost squeeze with scale synergies. With increased cost pressure, sub-scale companies will look to secure synergies and improve negotiation positions with operators. The competitive landscape may change quite fast. Even companies that have no M&A intentions will need to understand how the dynamics impacting their business will change as their competitors and customers realign.

The oil-field services sector is poised for a major wave of M&A activity as large companies make strategic and scale synergy moves. Who will the winners be? At the other end of the hourglass, financial investors with plenty of capital can pick up companies at the right price. Will they have the confidence to invest in the face of lower, more volatile oil prices and a sharp downturn in service sector demand?

Financial investors: growing involvement in key sectors

These companies account for 21 percent of the transaction value in 2014 (similar to 2013’s 23 percent). Most transactions are in the upstream sector. Examples of investment firms active in 2014 M&A include Apollo Global Management (acquired Encana’s Bighorn assets in the Alberta Deep Basin for $1.8 billion), Al Mirqab Capital SPC (acquired Heritage Oil for $1.8 billion), and Morgan Stanley (acquired 11.86 percent of Argentine energy group YPF from Repsol for $1.4 billion). The 2014 third-quarter activities are largely driven by private equity buyers, including Blackstone, Templar Energy, Mountaineer Keystone, and Vin Oil and Gas.

“…returns from oil and gas investments, albeit risky with price volatility, are too good for a lot of funds to ignore.” —Financial investor

Despite the price volatility, which does not lend itself well to traditional financial investor models, and the profitability pressure, financial buyers’ interest in the oil and gas industry is expected to continue. With more focusing on energy and their abundant fund availability, more deals are likely to come from financial investors.


Over the past few years, financial investors have focused on the oil services sector. However, there are signs that they are expanding their interest to operators with bigger or more complex assets and larger capital needs.

Feedback from many in the oil industry highlights that some financial investors are new to the market and have a poor understanding of oil and gas and its risks. This can significantly drive up valuations on assets. To succeed, financial investors need to appreciate the risks and cyclical nature of the upstream sector and the need to take a long-term investment view to realize full value.

“Plenty of capital looking for opportunity with the right operator.” —Financial investor

Downstream M&A could be an area of opportunity for financial investors. Integrated companies are reviewing their portfolios and offloading some downstream assets to build up cash for upstream investment. Cash flow and margins downstream can balance those upstream and are somewhat more stable (as oil prices are eventually passed through), which better matches traditional financial investor models.

The recent declines in oil price will create a dynamic shakeout in the sector. Financial investors that have plenty of capital and are still looking for a home in the sector have a unique opportunity to participate given the stressed cash flow of some firms. The question is, who has the risk appetite to take on the best opportunities in what will be a turbulent time for those in oil and gas.

The New Competitive LandscapeStrategic deals over the next six to 12 months will help define the winners in a new competitive landscape. Cost and cash-flow pressures will be intense for all. IOCs and independents will cut near-term capex, particularly for high-cost and less economically robust projects or those with returns that are further out. With fewer projects at a more measured pace, these firms will be able to design and plan projects more effectively, which will lower costs. Exploration in frontier, deepwater, and other high-cost areas will be drastically cut back. With a different set of drivers, NOCs are likely to pace their investments to meet economic and political agendas set by their governments. Service companies will experience a sharp drop in demand—some areas, such as deepwater drilling, sooner than others—and will need to get their fixed costs down fast.

Against this backdrop, our analysis and discussions with industry executives reveal several important insights to consider when looking at the opportunities and threats from likely M&A across the oil and gas industry:

• A new wave of M&A will arise across the value chain in the next six to 12 months, with a window of opportunity that may be shorter than expected.

• Coupled with the oil price slump, recent trends in the industry will exacerbate the differences between those that thrive and those that simply weather the storm.


Authors

Richard Forrest, partner, London [email protected]

Thomas Luedi, partner, Hong Kong [email protected]

Vance Scott, partner, Chicago [email protected]

Alvin See, principal, London [email protected]

A.T. Kearney contributors to the study:

Americas: Vivek Chidambaram (Houston), Dario Gaspar (São Paulo), Sean Heinroth (Houston), Neal Walters (Canada), and Herve Wilczynski (Houston)

Europe, Middle East, and Africa: Jose Alberich (Middle East), Joerg Doerler (Russia), Lars Eismark (Nordics), Alberto Fumo (London), Tobias Lewe (Germany), Jim Pearce (London), Victor Perez (Madrid), Willem Plaizier (South Africa)

Asia: Vikas Kaushal (India), Chris Livitsanis (Australia), and Anshuman Maheshwary (India)

• Asian and some other NOCs are more likely to play a major role as buyers, while IOCs will continue to divest and selectively pursue acquisitions.

• Independents under pressure will offer solid opportunities for those strong enough to take advantage of the situation. More adventurous financial investors may also become buyers.

• The oil-field service sector has all the ingredients for consolidation and major M&A activity from financial investors. The wildcards are the non-traditional service companies, such as oil and gas equipment engineering firms, that could make strategic moves toward building service capabilities in time for an upturn.

The new oil and gas industry dynamic will present some rare opportunities for those willing and able to adopt contrarian strategies against low and volatile oil prices, a drop in demand for oil services, and the need to focus on reducing costs. If supply holds up and demand growth remains slow, oil prices may continue to fall and do so for a longer time period. But in due course, prices will rise again. The window of opportunity may be shorter than some think. Strategic M&A deals in 2015—whether acquiring, partnering, or divesting—will help define the winners and losers in the new industry landscape.


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Presentations & Public Speaking

Mergers and acquisitions in oil and gas