Buying oil and gas assets in a downturn – it’s been a golden opportunity that’s been readily seized upon by private equity (PE).
These financial investors have poured capital into the sector. Most of the buyers will aim to sell within the next three or four years.
But will they be able to exit and deliver the requisite high returns to their backers within the planned timetable? I asked our analysts Greig Aitken (Global M&A) and Rob Clarke (US unconventionals).
What’s PE bought? PE has spent over U.S.$64 billion since 2015. The U.S. has been the primary target – U.S.$44 billion spread across shale gas plays (U.S.$20 billion) and tight oil (U.S.$18 billion) with the remainder in conventional assets.
Private equity’s earlier success with shale gas created the impetus – rampant U.S. Lower 48 production growth and a fragmented corporate landscape presented a deep pool of opportunities.
Most of this latest wave of PE capital has been split between two strategies – early-stage lease-and-drill versus acquire, exploit and optimize.
Europe is the other honeypot. PE has invested U.S.$13 billion over the last four years. Legacy incumbents and utilities in the mature North Sea have been selling to rationalize portfolios. PE stepped in, acquiring an array of positions, from explorers and developers to full-cycle E&Ps. PE now has 0.5 million barrels of oil equivalent per day (boed), or nearly 10% of total North Sea production, up from almost zero five years ago.
How can PE create value in oil and gas? It’s the private equity playbook to maximize equity value – portfolio restructuring; cutting costs; operational screw-tightening; tight capex and working capital discipline; a laser focus on cash generation, leverage and financial engineering; plus, occasionally, bolt-on acquisitions. In what’s frequently a much shorter investment period compared to the industry’s cycle, the key to success is experienced, astute and incentivized management.
All deals are expressly ‘value-driven’. PE is seeking to take advantage of depressed or under-appreciated asset valuations in a buyer’s market where, for strategic reasons, sellers are looking to release capital.
A recovery in commodity prices may not be explicit in the strategic rationale but makes life a lot easier. Timing is everything – in early 2017, some PE buyers of producing North Sea assets won an immediate windfall as the oil price leapt by 50% in the first year of ownership.
The assets acquired won’t likely be the finished article. Business development is invariably central to the strategy. In the Permian, most won’t spend much on drilling wells – it’s about building well inventory to put in the shop window for buyers with offset acreage. Mature-asset PE players in the North Sea have been buying complementary assets and extending portfolio life.
How is the exit route shaping up? Right now, not so good. The favored route for PE is almost always a trade sale to maximize value in cash. An initial public offering (IPO) is an alternative but depends on the vagaries of the stock market.
Both options are essentially closed off for now. Activity in U.S. M&A has petered out and the mooted sale of multiple high-profile Permian players has yet to materialise. The sell-off in U.S. Independents’ shares this year reflects the difficult market – perennially weak cash generation, soft commodity prices and a lack of access to finance have killed investor interest. Critically for PE sellers, perceived value in drilling inventory has evaporated.
Majors, including BP and Shell, are looking to build on their Permian positions. They are in no hurry. Buyers need to be sure of the value case to convince their own, sceptical shareholders. PE owners have little choice in the meantime but to execute to plan, focus on the cashflow and await an uptick in sentiment.
In Europe, Big Oil are the ones selling, so an IPO may be the preferred route. There’s certainly a gap in the market with a dearth of bigger, listed Independents. But it won’t be easy. PE will need to present a differentiated growth story, a clear strategy for the energy transition and meet environmental, social and governance criteria to command investors’ attention. Most European PE-backed players are still in the development stage and have a bit of time to work up a rounded package.
Wintershall DEA is scheduled for an IPO in 2020, and much bigger than most prospective PE-backed packages (U.S.$20 billion, NPV10). It will be a critical bellwether for PE aspirations.