Ernst & Young: Energy Services Merger Activity Only Tip of the Iceberg

The oil and gas industry is adapting quickly to the changing global environment, but Canadian companies are still approaching new opportunities with caution, according to a new Ernst & Young report, "Lessons from change -- Cautious optimism in the oil and gas industry."

"The last 12 to 18 months have been extremely difficult for energy services companies in the Western Canadian Sedimentary Basin. As a result, we've seen very little M&A activity over that time period," said Spil Kousinioris, Partner in Ernst & Young's Mergers and Acquisitions practice in Calgary. "Valuations were low, and companies could give little or no guidance on future earnings, meaning that companies -- both large and small -- were taking a wait-and-see approach to M&A."

Despite this, Kousinioris explains that we're now starting to see a renewed, yet cautious, interest in transaction activity in energy services, from both domestic and large multinationals (primarily US companies looking to enter and or enhance their presence in the Canadian marketplace).

Perhaps most importantly, capital markets are starting to open up, with better access to both debt and equity. Private equity participants are also beginning to re-enter the marketplace, looking to deploy capital that was previously being held.

"Over the past year or so, there was a tendency for buyers to wait, thinking valuations would continue to come down," said Kousinioris. "Now these potential acquirers believe that valuations are approaching bottom. In addition, some vendors who were unwilling to transact are now accepting the new pricing paradigm -- meaning that the gap between what buyers are willing to spend and what sellers are willing to sell is narrowing, heating up the transactions market."

Notwithstanding the uptick in transaction activity, the report also finds that many companies have no choice but to transact as balance sheets remain under considerable pressure.

Particularly relevant to the experience of Canadian exploration and production companies is the fact that natural gas prices have hit seven-year lows. Historically, oil and gas prices have traded in tandem, but natural gas demand fell during the recession, while production remained relatively resilient and storage reached record highs. Low prices and lingering uncertainty have players in the natural gas market reluctant to transact, unless they're doing so at distressed prices.

These challenges in the natural gas market put energy services companies with a bias towards oil at a competitive advantage in the transactions market.

"With oil prices hovering around $75 to $80 a barrel and strong long-term fundamentals, there's a renewed interest in the heavy oil and the oilsands space in particular," said Kousinioris. "Companies that are levered to oil or looking to enter new markets have demonstrated a great deal of interest in transaction opportunities."

Kousinioris explains that the oil and gas industry has a long and successful history of coping with volatile prices and challenging operating environments. This experience will continue to serve companies well -- those who demonstrate the foresight to apply lessons from change will establish their leadership as the new global commodities environment unfolds.