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Supplement: Upstream M&A Activity Verges on Tipping Point

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The upstream mergers and acquisitions (M&A) market has become something akin to a pressure cooker. Conditions are increasingly ripe for a sharp uptick in corporate consolidation and asset transactions, but the tipping point hasn't been reached just yet. It's been over 10 months since international benchmark crude prices last saw $100 per barrel, but with the ensuing price collapse as rapid as it was -- Brent hit a six-year low of $45.19/bbl by January -- and months of heightened volatility following suit, the process of negotiating M&A valuations has been a tall order. Interested sellers have a compelling incentive to not part with assets or exit the market at trough prices, and the speed with which crude prices recovered in the 2008-09 downturn has made sellers even more gun-shy about pulling the trigger too quickly. At the same time, buyers are looking out across a robust inventory of assets and companies up for sale -- consultancy IHS estimates over $200 billion in upstream assets are in play, while M&A outfit 1Derrick pegs that figure near $117 billion -- and see many advantages in waiting. After all, if sellers are not willing to part with assets at valuations reflecting a more bearish crude and natural gas price outlook, buyers risk overpaying if commodity prices are persistently low. Alternately, should oil and gas prices recover in short-order, valuations might strengthen a bit from current levels, but buyers never had a window to capture major bargains in the first place, so little would be left on the table. At the end of the day, the risk/reward balance for buyers and sellers is still not sufficiently aligned to drive a meaningful amount of activity in the upstream M&A market. That's not to say some life hasn't been breathed into the system over the last few months -- although the first quarter of 2015 admittedly set the bar for improvement exceptionally low. Including a February when total upstream M&A spending hit the second-lowest monthly rate in the 1Derrick M&A database, the first quarter witnessed just $6.9 billion in deal activity, an EI Finance analysis of 1Derrick data found. That compares to a quarterly average of $45 billion over the last seven years, according to the consultancy (EIF May6'15). April saw Royal Dutch Shell's $82 billion bid for UK gas giant BG -- a historic tie-up that propelled second-quarter upstream transaction spending to $104.7 billion (EIF Apr.15'15). But excluding that merger, the $22.9 billion in other M&A spending still made for a slow overall market. By comparison, buyers and sellers were able to agree nearly $37 billion in deals in the third quarter and $45 billion in the last three months of 2014 -- despite oil prices falling like a knife over that period. Still, one sign of encouragement for those looking for M&A markets to pick up steam can be found in the number of $100 million-plus deals agreed in the second quarter of 2015. The first three months of the year witnessed just 17 deals of this caliber -- the market averaged 54 per quarter in the previous five sessions -- and a single deal worth more than $1 billion: French major Total's $2.2 billion bid for a 10% stake in Abu Dhabi's 1.6 million barrel per day onshore Adco concession (EIF Feb.11'15). In the second quarter, however, buyers and sellers were able to pen 30 deals worth $100 million or more apiece, and nine billion-dollar-plus deals rolled in, although one of those -- a $5.54 billion bid for Colombia-focused Pacific Rubiales -- has since fallen through. Beyond Shell-BG, other flashes of consolidation emerged. There was US-based Noble Energy, which agreed and completed the $3.85 billion purchase of smaller independent Rosetta Resources (EIF May13'15). That deal gave Noble access to proved barrels in the Permian and Eagle Ford Shales for roughly half what it had spent per boe on finding and development over the past three years, notes Chris Sheehan, director of transaction and valuation research at IHS Energy. There was also Canada's Crescent Point Energy, which continued its long-standing history of acquisitions in the country's oil patch with the $1.25 billion takeover of struggling Legacy Oil + Gas. The deal caps what has broadly been a more active corporate M&A sector in Canada than in the US, as cash-strapped producers have a tougher time accessing capital in the Great White North. Another catalyst for more robust activity in Canada is the fact that more of Canada's struggling firms have quality assets despite their financial issues, whereas top-tier assets in the US tend to already be concentrated in the hands of better-heeled producers (EIF Jun.24'15). Another early mover is Vanguard Natural Resources, which has used the rather distressing environment for US upstream mater limited partnerships (MLPs) to pick off two peers to greatly expand its inventory yet reduce its leverage in the process. Although neither deal touches $1 billion on its own, combined Vanguard will spend over $1.1 billion scooping up LRR Energy and Eagle Rock Energy Partners -- a sizeable move for a company whose own market capitalization tallied just $1.4 billion before the first deal was announced. The consolidation moves follow peer BreitBurn Energy Partners' $3 billion buyout of MLP peer QR Energy last year (EIF Dec.24'14). Top 15 Upstream M&A Transactions, H1 2015 Announce

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