Our 15th Capital Confidence Barometer characterizes the oil and gas M&A market as one where executives continue to remain positive about acquisitions, but are equally aware of challenges in concluding a deal.
The ongoing transformation of the industry has led to a record number of assets on the market, driven by distressed sales and portfolio restructuring. However, this has not translated into a significant volume of completed deals due to the persistent valuation gap between buyers and sellers.
This is a result of buyers expecting bargains at a time when sellers are loath to part with quality assets at low prices, as well as their differing views about the future of commodity prices. There have been some signs of revival in the M&A market during the last two quarters, and we believe the momentum is set to continue.
Oil and gas executives view the global economy as stable but recognize an increase in downside risks. Global economic forecasts support an outlook for 2016 growth to be similar to that in 2015, but the demand outlook has softened with the IEA expecting a slowdown in both demand for crude oil and natural gas.
Companies are being challenged not only by continuing uncertainty over where faster economic growth will come, but also by unsettling events such as the UK’s decision to leave the European Unit (EU) and the uncertainty over the planned hike in US interest rates.
Executives view the global economy as stable
Nearly half of the oil and gas respondents believe the global economic situation is stable. However, there is an increase in the number of companies (31%, up from 13% in previous survey) that view the economy as declining.
Unsurprisingly, oil and gas companies are slightly more pessimistic than the broader global sample of respondents.
Q: What is your perspective on the state of the economy today at the global level?
Lower confidence on earnings and credit availability
Due to the steep decline in the price of oil in Q1, and increase in volatility, oil and gas executives’ outlook on earnings, equity valuations and credit availability has shifted from positive to stable or negative during the past 12 months.
This sentiment suggests a growing acceptance of prolonged low oil price environment and may also be influenced by scaled down/withdrawn credit lines from banks, concerns over the continuation of quantitative easing, especially by the European Central Bank (ECB), and timing and pace of US rate rises.
Q: Please indicate your level of confidence in the following at the global level.
Increased global instability and oil price volatility are key risks
Not surprisingly, more than one-third of the oil and gas company respondents see high volatility in currencies, commodities and capital markets as the key economic risk to their corporate (36%) and M&A strategy (38%). Oil and gas executives continue to perceive significant geopolitical risks, especially in the Middle East.
Uncertainty regarding OPEC’s role in managing the oil market, possible change in dynamics between Saudi Arabia and Iran, are likely to keep oil prices volatile. Political instability leading to disruptions in oil supply in Nigeria and populist pro-Nationalist policies in some countries are also making oil and gas executives cautious.
Q: What do you believe to be the greatest economic risk to your core business and M&A strategy over the next 6–12 months? Select your top two risks in order of importance.
Corporate strategy of oil and gas companies is being reshaped by a multitude of factors, ranging from prolonged depression in commodity prices to decelerating oil demand, growing influence of digital technology and concerns over climate change.
While companies need to focus on cutting costs and achieve efficiencies in the short-term, they also need to focus on long-term growth amid changing industry dynamics through investments in technology, clean energy and the right talent.
Innovation, technology and sector convergence transform the oil and gas industry
Oil and gas companies are increasingly relying on innovation and technological advances to reduce costs and improve operational efficiency. OFS companies are embedding digital and analytics solutions into oil and gas equipment and services. The oil and gas industry is also facing slowdown in global energy demand, changing demand patterns and growing threat from use of renewables as concerns over climate change intensify.
Q: From where do you see the most disruption to your core business in the next 12 months? Select your top two disruptors in order of importance.
Technology and automation is at the heart of companies talent strategy
The oil and gas sector has typically been a slow adopter of digital technology for above ground risk and project management. However, the industry is now increasing investment in data analytics to improve efficiency and reduce costs. Changes in the skills required in a more technology-driven environment are compelling companies to reskill their employees.
Q: How do you think that advances in technology will change your employment or talent strategy? Select all that apply.
Growing importance of digital
The oil and gas sector’s increased need to become interconnected to improve efficiencies and the ability to make real-time decisions are driving increased adoption of digital models. The impact of digital technology and sector convergence is also compelling companies to identify inorganic growth opportunities.
Oil and gas companies struggling with the financial reality of excess debt and squeezed profits due to low oil and gas prices, are considering rationalization of portfolios and, consequently, M&A and joint ventures are high on the boardroom agenda.
Q: Considering the answers given in this survey, which of the following will be most prominent on your boardroom thinking during the next six months? Select your top two issues in order of importance.
Oil and gas M&A activity has shown signs of revival in the last two quarters, with robust deal volumes in upstream. While we are yet to see the volume of big-ticket deals comparable to previous industry downturns, relatively stabilized oil prices coupled with recent transactions by majors, has stoked confidence. The US, primarily the Permian, continues to be the most favored destination for oil and gas acquisitions.
Favorable economics, even with low commodity prices, shorter drilling and completion times as well as flexibility to moderate production to suit market dynamics has made them investors’ top pick. Canada also continues to attract investment.
While we do not see a return to the record highs of 2015, oil and gas executives remain positive about deal making. Investors waiting to see if the downturn has definitely hit bottom are more likely to start doing deals in 2017.
Oil and gas executives still positive about acquisition opportunities
Our survey showed a more pessimistic response around quantity and quality of opportunities this time around, consistent with the relatively flat state of the market around the time it was carried out.
However, executives view the quality of acquisition opportunities as robust, with more than 80% of the respondents having positive or stable outlooks on the quality of the assets in the market. With several deals that have been pulled or cancelled during the last twelve months, the respondents are slightly less confident about closing deals.
Q: What is your level of confidence in the following at the global level?
Oil and gas companies have strong deal pipeline with almost 50% having 5 or more deals
Companies have more deals in the pipeline: nearly half of the oil and gas respondents have more than five deals in their pipeline, but mainly medium sized. Furthermore, more than one third of the oil and gas executives expect their pipeline to increase in the next 12 months.
Q: How many deals do you currently have in your pipeline, regardless of deal size?
Q: What is your largest planned deal size in the next 12 months?
Persistent valuation gap a challenge
The gap in buyers’ and sellers’ deal valuations has been stubbornly persistent. More than half of oil and gas executives report that while selling an asset, their expectations of transaction valuations are 10-25% higher than those of buyers.
With a record number of assets to choose from, buyers have been acting with discretion and are prepared to walk away from a deal rather than overpay. Similarly, sellers are unwilling to part with quality assets at low prices, especially as financial pressures increase.
In addition, oil prices movement close to the $50/bbl mark may also have raised sellers’ expectations for further price recovery in the market and better valuations. Notably, 87% of oil and gas executives admit to have cancelled/failed to complete a planned acquisition in the past 12 months.
A majority of respondents also agree that the valuations will likely remain at the same levels in the coming 12 months and the bid-ask spread will persist at the current levels (42%) or may even grow (48%).
Q: How do sellers’ expectations of transaction valuations currently compare to those of buyers’?
Oil and gas M&A expands beyond core sector and traditional structures
As the oil and gas sector continues to undergo transformation, external influences such as growing climate change and digital disruption are compelling companies to look beyond core sector for acquisitions. To reduce their carbon footprint, oil and gas executives seek to increase the share of natural gas and invest in renewables and clean technologies.
They are increasingly considering acquisition of technology as the sector increases its investment in the digital space. Companies are keen to acquire the right talent and innovation capabilities to navigate the changing business environment.
The industry may also witness more innovative deal structures, as firms test the waters with joint ventures, strategic partnerships or become more creative with hybrid equity type investments.
Q: What is the main strategic driver for pursuing an acquisition outside your own sector? Select your top two drivers in order of importance.
Q: What is the main strategic driver for pursuing acquisitions in your current sector? Select your top two drivers in order of importance.