Analysis: Unconventional Onshore Plays Still Center of Energy M&A Activity
According to Deloitte's Oil & Gas Mergers and Acquisitions (M&A) Report for Mid-Year 2010, exploration and production (E&P) transactions continue to make up the majority of merger and acquisition activity in the oil and gas industry, comprising 76 percent of all oil and gas transactions in the first half of 2010. The center of M&A activity is the rapid rise of natural gas E&P in unconventional formations onshore.
"While conventional deals easily outnumber them, our research shows there were six deals worth $52 billion for U.S. unconventional reserves and acreage," Deloitte said in its report, noting that the majority of these deals are targeting Northeast U.S. properties, once considered an exploration backwater, due to the Marcellus shale drilling boom.
While the energy industry is getting back to normal, as indicated by the healthy rise in deals so far this year, credit is generally harder to find that it was during the boom years, with lenders scrutinizing loans and higher thresholds for approvals.
"Complicating the oil and gas M&A market are the effects of the Gulf oil spill and drilling moratorium. There is a lot of uncertainty due to potential changes in regulations and in perceived risks," said Jim Dillavou, partner, Deloitte M&A Transaction Services.
A possible outcome of the moratorium and related rule changes is an exodus from U.S. waters by many drillers, Deloitte said. Tougher permitting rules have significantly slowed drilling in shallow waters of the Gulf not covered by the moratorium, and Congress and regulators currently are rewriting the rules of deepwater drilling, which could have an even greater impact. A number of companies, especially small and midsize E&P players, are re-evaluating their holdings in the Gulf and most parties are re-evaluating their partners. As a result, Deloitte expects several companies will seek to exit or reduce their Gulf of Mexico operations.
Deloitte said experience has shown the offshore industry has staying power in the Gulf of Mexico, but in the near term, the uncertainty created by regulatory changes and shuffling of assets could add momentum to the already strong revival of onshore U.S. exploration.
"Less than a decade ago, the onshore North American exploration and production business looked like it was in permanent decline. Now it's powering oil industry M&A. Buyers from around the world – France, Korea, India and the UK to name a few – are seeking to acquire the expertise to go after unconventional reserves," Deloitte said in its report.
Deloitte's research indicates that the strongest buying interest is from China, where national oil companies and other firms are looking to invest their large reserves of U.S. currency, formerly invested in Treasuries and other liquid investments, into U.S. natural resources.
Chinese and Indian companies have mostly been buying minority stakes, which has given them entry into the U.S. market without many of the management and political issues associated with having a controlling interest.
The foreign buyers are offering ready cash, and Deloitte has found that, in several of the deals, they have agreed to a carried interest arrangement, buying a modest up-front interest for a significant premium and then funding most of development progresses. According to Deloitte, this is a welcome structure for U.S. companies that added debt to lock up leases and often committed to an aggressive development timetable.
Deloitte reported five service sector deals over $1 billion throughout for past 12 months – the largest topping $11 billion. Looking ahead, the activity is likely to remain steady but the targets will be smaller. "We've seen some big blockbuster deals. What we may see next is activity involving the next tier of smaller-sized companies," said Trevear Thomas, principal with Deloitte Consulting.
These deals allowed the biggest players to continue their long-term effort to expand geographically and deepen their broad line of products and services. Recent acquisitions have targeted products like drilling mud and specialty chemicals as well as services like pressure pumping and subsea construction.
Eighteen M&A deals in the service sector took place during the first half of 2010, a similar level seen during the same period in 2009, but large deals pushed the average transaction value to $1 billion this year from $236 million a year ago. The stepped up investment in finding and producing natural gas and oil from unconventional formations is a primary driver.
"A key characteristic of shale is service intensity," Thomas said. "You have to keep drilling to maintain production. You have to keep producing to maintain the leases. Thus shale activity bodes well for oilfield services organizations."
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