Transacting at $50 - PDF document

Transacting at $50 oil Upstream A&D pl ays and complexities in today’s price environment www.pwc.com 2 PwC Transacting at $50 Changing transaction market dynamics During the past five years, the oil and gas deals market has reflected the energy industry’s confidence, with rising transaction value and volume. US exploration and production ( E&P ) companies have grown rapidly through both acquisitions and the drill bit, focused in particular on unconventional plays in the US, resulting in a robust inventory for both asset and corporate transactions. The oil and gas transaction market ended 2014 with a tapering off in deal volume, impacted by the late 2014 collapse in o il prices. Subsequently, falling upstream earnings have now put the brakes on expansion plans and led to capital spending cuts across the industry. Facing such market uncertainty, energy companies have been re - evaluating their asset portfolio and adjusting their acquisitions and divestitures ( A&D ) strategies by loading up their war chests and waiting for a possible market rebound. Historically, oil prices have influenced upstream deal values. During the last downturn, the implied proved reserve values dec lined rapidly as oil prices fell, followed by a gradual recovery. Prices varied across asset types, with unconventional assets at times priced at a premium as the recovery coincided with the onset of the shale revolution. It is presently unclear as to whe ther the current downturn will follow the same pattern, which means deal values may have further downside potential. International deal value vs. oil price Source: IHS, PwC analysis 0 20 40 60 80 100 120 140 0 5 10 15 20 25 30 35 Nymex Oil 12 Mo. Strip, US$ Implied proved reserve value (IPRV), US$/Boe Quarter and year Average of Conventional IPRV Average of Unconventional IPRV Average of Offshore IPRV Average of Nymex Oil 12 Mo. Strip Day Before Deal Announce US$ PwC Transacting at $50 3 Though 2014 was the strongest year for deals since 2010 in terms of both deal volume and value, the market has seen a decline in the transacted volume at the end of the year, as crude prices dropped. With plenty of cash currently sitting on the sidelines, there appears to be a disconnect on valuation between buyers and sellers. Average deal value has declined from over $ 20/boe of proved reserves in the third quarter to about $ 13/boe in the fourth quarter of 2014, with sellers likely being reluctant to sell at this level. Over the past several months, as the economics of many assets have dropped below the full lifecycle cost, the US rig count has declined and some unconventional plays have fallen out of favor. In early 2015, the assets for sale worldwide amounted to about $150B, with the most in the US . So what is happening with the US producers? Upstream sector leverage has been on the rise as companies borrowed heavily to fund growth using low - cost debt. However, recent credit and debt downgrades will likely lead to an increase of sub - investment grade and distressed debt. This will increase once again as 2015 hedges rol l - off and low prices persist. To date, many players have been able to sustain their debt or restructure it with mezzanine financing to keep from distressed sales of assets. 4 PwC Transacting at $50 5 PwC Transacting at $50 E&P net debt to EBITDA ratio (2014) Source: Bloomberg, PwC analysis In the waning days of the 2000’s gas boom, many producers were able to sell down large gas positions to foreign oil companies to sustain drilling programs, profitability and cash flow. This time around, foreign b uyers appear to be more selective in their acquisitions given the global impact of low oil prices. Private equity has also been relatively silent in the acquisition space, as near term monetization / valuation requirements do not lend themselves to a forward curve that merely reaches into the $60’s within the window. As mentioned above, many of the US E&P companies have put transactions on hold, shifting focus to capital preservation and cost reduction. Meanwhile, higher debt to EBITDA ratios pose credit ris k, and cooled equity markets make capital management difficult at best. Reduced share buy - backs and dividend cuts may not be enough to address the cash shortfall. More draconian measures involving the asset portfolio will likely be required. Despite the ch allenges, it is important to get over the shock and embrace the new market reality to move forward. 2 8 6 5 3 5 1 4 2 1 2 0 1 0 0 1 0 1 2 3 4 5 6 7 8 9 0 - 0.5 0.51 - 1 1.01 - 1.5 1.51 - 2 2.01 - 2.5 2.51 - 3 3.01 - 3.5 3.51 - 4 4.01 - 4.5 4.51 - 5 5.01 - 6 6.01 - 7 7.01 - 8 8.01 - 9 9.01 - 10 10.01 - 15 # of companies Net debt: EBITDA ratio Note : In 2014 , selected E&P companies had a median Net Debt to EBITDA ratio of 2.0. PwC Transacting at $50 5 Advantages of acting early Companies have been hesitant to divest, especially those assets that provide stable cash flow or offer high - growth potential in the future. In some cases, maintaining a certain asset mix or a core position in key plays has become part of many producers’ st rategic positioning. The deteriorating market provides an advantage to early movers to get ahead of further discounting, especially if the downturn is protracted. Getting assets onto the market early will allow companies to sell them on reasonable terms a t today’s prices rather than at potential future distressed prices. If the oil market remains in the doldrums, more properties will likely be forced onto the market, driving competition for buyers’ attention. Furthermore, divesting early can reduce the dra g on the financial position and free up cash to pay down debt in time to preserve credit quality and fund operational initiatives. The best sale candidates are non - core assets that can be identified through a strategic portfolio rationalization. Some E&P companies have already taken or considering near term action. For instance, during the past 12 months, Apache has sold over $7 billion in assets to focus on core US shale plays. Similarly, during the last downturn, Devon acted aggressively to reposition i tself from a diversified player to a US unconventional player focused on growing its liquids position. Other E&P companies that transacted during the last downturn outperformed the market segment during the subsequent year. For instance, Anadarko sold stak es in multiple offshore fields, and EOG made unconventional asset acquisitions during the period. Select E&P stock performance – Last downturn Source: Bloomberg, PwC Analysis Upstream transaction activity may be about to pick up. In late March, Whiting Petroleum announced a public offering of its 35 million shares and nearly $2B of senior notes. A transaction of this size could open the floodgates for an upcoming wave of upstream deals. 0% 25% 50% 75% 100% 125% APC CHK EOG XOP - E&P ETF 1 PwC Transacting at $50 6 PwC Transacting at $50 Making A& D programs work in a world of $50 oil A programmatic approach to A&D that was effective in a rising market should now be replaced with a more selective deals strategy. Continuing to actively screen opportunities w ill allow companies to take advantage of discounted prices and opportunistically fill in position in core regions or play types to support business growth. Select acquisitions can help gain access to attractive exploration opportunities and maintain the op portunity funnel. Focused A&D strategy balanced with organic activity helps withstand the down market and position for future recovery to generate industry - leading returns in the long run. Companies need to have defined criteria for assets they want to keep or sell and become proficient in deal execution. The evaluation of a given asset acquisition or divestiture should involve a robust analysis of asset performance and potential for value creation in terms of revenue and cost synergies. Failure to ach ieve operational integration of an acquired asset or get rid of back office costs during carve - out often results in excess costs. Disciplined transaction management can ensure and accelerate value capture while mitigating the risk of business disruption. So what should a producer do in the low price environment? As a starting point, an E&P company should develop an objective, analytically backed understanding of how the assets considered for divestiture or acquisition align with its portfolio and the mar ket environment. Additionally, it is also critical to build A&D capabilities to rapidly act on opportunities as they arise - specifically, the ability to rapidly and efficiently perform asset assessment and due diligence as well as post - transaction on - and off - boarding of the assets. No one can say with certainty how this market will recover, therefore successful companies will be the ones who have the ability to react quickly as the market unfolds. © 2015 PricewaterhouseCoopers LLP. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please s ee www.pwc.com/structure for further details. Contacts John Corrigan Vice President, Strategy& john.corrigan@strategyand.pwc.com Svetlana Valonis Director, PwC svetlana.valonis@us.pwc.com