Energy supplement: The return of dealflow

There is something of a revivial going on in the oil and gas sector, at least in terms of deal activity. In January alone there were 68 private equity deals worth $43.5 billion, according to EY.

That compares with $130 billion in the whole of 2016, which was driven by a big increase in transaction volumes in the fourth quarter. Upstream assets were the most in demand, signaling a recovering appetite for production expansion.

There’s no doubt the stabilising oil price was a factor in the resurgence. Sentiment in the Brent crude oil market is less bearish than it was last year and having averaged $53 per barrel in the year to date, prices are around $10 per barrel higher than in 2016 when prices hit a 13-year low.

While prices have risen year on year, they are still around half the level seen between 2011 and 2014 as oversupply continues to weigh on prices. Efforts by the Organisation of the Petroleum Exporting Counties to drain the chronic glut in the oil market by cutting output are being offset by the steady rise of shale rig numbers in the US, maintaining downward pressure on the market.

The prolonged downturn has prompted many energy giants to exit the market. Among them is
French utility Engie which has offloaded its gas and oil production assets in both the US and Europe and is turning its attention instead to the regulated services such as energy services and grids.

But the issues don’t appear to be putting off energy-focused private equity funds, which are currently ploughing dry powder into the emerging opportunities.

“Global oil consumption is expected to rise as emerging markets want access to the same amenities as developed countries. The additional US production is not forecast to be sufficient to cover this,” says Gordon Huddleston, partner and co-president at Aethon Energy. “Additional production in the US is not necessarily going to be sufficient to shore up demand in the long term.”

DRILLING FOR A DEAL
Headline deals in the US are in the shale sector, and the Texan Permian Basin, in particular, has become the hot spot for M&A due to its strong production profile and low-cost resources. Among the private equity firms getting a slice of the action are Pine Brook and Riverstone Holdings, who agreed to invest up to $600 million in newly created oil and natural gas explorer Admiral Permian Resources in March. In April, Blackstone agreed to acquire EagleClaw Midstream Ventures, a deal that included more than 375 miles of natural gas pipes.

While most producers are targeting oil, it often comes mixed with a substantial volume of natural gas. This has presented further opportunities for investment and allowed the country to join the global liquefied natural gas trade; in 2016 the first exports from Cheniere Energy’s Sabine Pass terminal in Louisiana took place.

Proximity to Sabine Pass was one of the factors behind Aethon’s acquisition of Haynesville Shale gas assets in the Louisiana Basin.

“It was an early shale play but it was over piped and as commodity prices fell it became capital contrained,” Huddleston says.

Describing the firm as commodity agnostic, Huddleston said it targets less popular assets, taking a different view on the potential upside. Its size allows it to put in place a long-term development plan.

“A lot of companies have increased their acreage, but they don’t have the resources to develop it. Others will flip assets – buying them up, drilling a couple of wells and moving on. We develop our assets, we can drill 20 rigs, we have larger scale development plans,” he says.

Huddleston says there are plenty of opportunities for private equity firms in oil, but Aethon is not targeting those at the forefront. “We try to find a niche, targeting the most out-of-favour assets. We believe that we have around one year to capitalise and act on new information. When we see a lot of interest it’s time to look elsewhere,” Huddleston says.

EUROPE OUT AT SEA
In Europe, activity has centred on UK and Norwegian North Sea oil and gas plays. Blackstone-backed Siccar Point Energy kicked off the deals in the market last August, acquiring an 8.9 percent stake in the UK North Sea Mariner field.

Deals have since gathered pace and two mega deals have been inked since the start of the year. With backing from EIG, Chrysaor acquired half of Shell’s North Sea fields for $3.8 billion in February and in May, French utility Engie agreed to sell its exploration and production business to Carlyle and CVC-backed Neptune Oil and Gas. The deal, which includes several fields in the UK and Norwegian North Sea, is expected to close in Q1 2018 and is valued at $3.9 billion.

Resurgent interest is attributed to both a rise in Brent crude prices and the fact that operating costs have fallen. Data from Oil and Gas UK show unit operating costs are now around $15.30 per barrel of oil equivalent, almost half the $29.70 seen in 2014.
“The stabilised oil price has driven a lot of investment. The price is much lower than at its peak, but there has been an acceptance that this is the new norm, and we have to get used to it,” says Arun Subbiah, partner at Petroleum Equity. “Lower prices have encouraged the drive for efficiency and cost reduction.”

Petroleum Equity is targeting upstream oil and gas opportunities outside of North America, and invests between $150 million and $250 million into assets. It also looks to partner with companies across the supply chain to further reduce costs.

Its portfolio company Alpha Petroleum recently entered into two agreements to advance the development of its Cheviot oil field, one of the largest undeveloped fields in the UK North Sea. One relates to a Front End Engineering and Design study of a floating production storage unit with Teekay Offshore Partners, which will be used in the oil field’s development. The second is with energy conglomerate GE Oil & Gas. The two companies will work together to advance subsea infrastructure for the field.

The firm has also identified a less crowded market – conventional onshore oil and gas assets. Last year it acquired a portfolio of German oil and gas field assets from US private equity firm Kimmeridge Energy. While European gas demand has been declining for a number of years, the region will be reliant on the fuel for the foreseeable future making it a viable play.

“Energy efficiency has contributed to falling gas consumption, but as coal-fired power plants are being phased out natural gas will step up,” Subbiah says.

Add to this a European Commission-driven initiative to diversity its gas supply sources away from Russia – which currently supplies around one-third of the bloc’s gas – and new security of supply initiatives, and it’s easy to see why European gas fields are an attractive investment option.

Despite the apparent opportunities, there is much less competition for deals in this area than in the North Sea.

“There hasn’t been the flood of interest onshore in Europe, and all our deals have been sourced bilaterally,” Subbiah says.

Whether opportunities continue to abound in the oil industry is uncertain. JPMorgan recently slashed its 2018 Brent crude price because of concerns about the possible end of OPEC production cuts expires. Add the second US shale boom to this and it looks like the glut could return with a vengeance in 2018. Gas assets, however, could continue to be fruitful. Despite falling demand, the fuel is expected to remain a key source of energy supply for the foreseeable future.