On 20 July, Chevron announced an agreement to acquire independent exploration and production company Noble Energy. Chevron valued the total enterprise value, including Noble’s debt, at $13bn.
The company said that the deal would give them “low-cost, proved reserves and attractive undeveloped resources that will enhance an already advantaged upstream portfolio.” In a statement, Chevron’s leadership highlighted its interest in Noble’s assets in Israel, as well as in US shale fields.
Was this the first sign of a coming period of mergers and acquisitions (M&A)? Will we see consolidation, where big companies acquire smaller ones, and how different will the industry look on the other side of coronavirus?
The Chevron deal, and what it means for the oil and gas industry
Westwood Global Energy head of consulting Arindam Das says: “I think the Chevron/Noble transaction is an example of two things. One, the companies disclosed figures of $300m of synergies that are likely to be realized. But more importantly, there is a strategic fit. Noble’s portfolio across the onshore US, plus the eastern Mediterranean, is of great importance to Chevron.
“The deal capitalises on the situation that a lot of independent companies like Noble find themselves in today, where they’re better off as part of a bigger conglomerate, which has balance sheet strength, financial discipline, and also good quality stock.
“More importantly, I think the whole impetus is the pandemic, because it gives you the opportunity to opportunistically buy assets at cheap valuations. The bigger names with good quality stock, will generally be the ones that would drive some opportunistic consolidations.
“In Australia, Woodside Petroleum’s CEO has been very vocal that they have been looking at opportunities very closely. It’s been one of the key points of emphasis for them since the pandemic. And that goes back to the point that was Woodside has a very strong balance sheet.”
Is this the start of a wave of mergers and acquisitions?
Many associate downturns with a wave of consolidation. While some companies might choose to splash out, Das doesn’t expect a tsunami: “Will we see massive consolidation? For me, the answer is yes and no. Yes in the sense that there will be a degree of consolidation, but no in the sense that it’s perhaps not quite as large as most people would like to believe it is.
“Access to capital is prohibiting a huge degree of consolidation in these markets. To a large extent, the oil and gas industry doesn’t have access to equity capital markets or debt capital markets. So raising new capital to consummate mergers and acquisitions is difficult.”
GlobalData senior oil and gas analyst Adrian Lara agrees. He says: “There is a general expectation for M&A activity to pick up, mainly because some companies have had a difficult time handling the post-pandemic reality and stronger companies see this as an opportunity to acquire assets.
“However, particularly in the United States, there is a huge corporate debt in the sector that can counter the impulse to buy. Normally, major oil and gas players are the ones better placed to take advantage of this low point in the cycle, but at the moment most major international oil companies are being very selective with their asset portfolio and their acquisitions. Particularly, European operators have started phasing out their focus on hydrocarbons, becoming energy companies by diversifying their business.
“Even if there are some oil and gas opportunities these operators would usually take, they would not necessarily be interested because of this shift in their goal. Indeed, the deal with Chevron and Noble Energy had a natural gas component, which is a commodity with a better or cleaner outlook than oil.”
What will make this downturn unique?
Lara and Das agree that, particularly in western Europe, the move away from reliance on oil will affect where companies look to invest. In this area, oil and gas operators pay more attention to environmental, social and governance (ESG) factors than ever before.
Shell’s 2018 purchase of First Utility and Total’s expanding relationship with Adani Renewables are two of many recent purchases outside the oil and gas sector. In August, BP CEO Bernard Looney announced his intention to invest $5bn per year in low-carbon projects, marking the direction of the industry in western Europe.
Das says: “Because there is a strong focus from investors in western Europe on the energy transition and ESG factors, getting shareholder approval to consummate large deals in upstream oil and gas may not be easy.
“There is a focus on the transition. That’s going to take place not only in western Europe, but I think slowly over in North America, and equally on the oilfield services side. Wood Group has diversified significantly from traditional oil and gas, and that theme is going to start to trickle down more into the mid-market oilfield service companies, because they will be more focused on long-term diversification and a greener agenda.”
Winners and losers: “Until the deal occurs, nothing is certain”
The Covid-19 pandemic and oil price war have caused huge changes in the price of oil throughout 2020. BP, Total, and Hess now have long-term price assumptions less than $60 a barrel, and the analysts say this could change their strategy entirely.
Lara says: “Rather than prioritizing possible M&A opportunities, oil and gas companies are focusing more on increasing the cost efficiency of their operations. Many have come to terms with the new oil price, and have prioritised trying to drive a positive cash flow with breakeven oil price of at least $40 per barrel. Once companies are able to prove such ability, and with a strong balance sheet, they can be more confident in acquiring smaller players and take on more debts.
“Still, there is indeed an expectation for an increase in the M&A activity during the next year. There is, for instance, an interest in Canadian unconventional assets operated by relatively small private operators.
“Companies involved in M&A activity in the post-pandemic world will need to have a strong balance sheet and a good record of free cash flow when prices were higher. Until the deal occurs, nothing is certain.”
The Covid-19 downturn has taken hold much more rapidly than a standard recession, giving companies little time to prepare. Restrictions to operations have also led to them having little opportunity to respond. As a result, Das reckons businesses will pay attention to unforeseen disasters, known as “black swan” events.
He says: “Also, what kind of instruments do businesses have taking into account these “black swan” events? Pre-pandemic, these unexpected events were never actually factored into business planning. I think today for most businesses, black swan events are part of the thinking and will become much more prominent.”
Lessons to take into the new normal
Das considered some of the other lessons for the world to come: “The first learning is something I think most oil companies have somewhat learned already from the previous downturn: do not focus on a $100 oil price environment anymore.
“I think, with the pandemic, it is important to learn the importance of having a strong balance sheet. This is especially true for shale extraction. Since 2016, they haven’t been able to raise a lot of equity, but they have raised enormous amounts of debt, and that’s now maturing.
“Another thing is around financial discipline. How do you manage your costs? What is the cost of production? What are the profits that you’re making? How are you reinvesting that? Going forward, I would imagine that people will look a little bit more closely into understanding liquidity, understanding their debt profiles, their capital structures, and just focusing on what’s right for the business.
“Across all industries, but certainly for the oil and gas industry, risk assessment is going to become much more important. Exploration is going to be under focus.
“Coming out of this, companies will be more fit for purpose, with capital structures that can withstand cycles, but also black swan events, much more focused on capital discipline, cash generation, and being fiscally conservative. That is about really understanding where to focus your business on, and how you think about aspects like exploration, and how that fits into your picture of the world.”