Better M&A Outlook Could Help Transition

The improved oil and gas price outlook and more favorable equity valuations have been a tonic for global upstream M&A this year. North American deal flow surged to pre-pandemic levels in the second quarter while signs of a recovery are emerging in other regions. Higher commodity prices may have eased pressure on Western majors and larger players to offload assets to help right-size balance sheets. But disposals could offer a way to cut emissions quickly while earning a return. The North American shale sector accounted for $39 billion in global deals during the quarter, while transactions elsewhere contributed just $3 billion, according to Energy Intelligence's Research & Advisory unit (PIW Jul.16'21). Deals with a significant equity component -- like Chesapeake's $2.2 billion acquisition of Vine Energy this week -- have spurred activity this year despite valuation uncertainty (related). Chevron CFO Pierre Breber said all-stock deals make sense because they act as a kind of hedge if prices rise or fall between buyers and sellers. Outside North America, Covid-19-related disruptions have served as a drag on cross-border transactions, according to Alex Msimang, managing partner of law firm Vinson & Elkins' London office. Lockdowns have prevented M&A teams from traveling to offices and asset sites to conduct critical technical due diligence, but that should now start to ease, he said. The majors and large-cap players have used the opportunity to hone their oil and gas portfolios rather than acquire new assets as capital discipline still reigns. These companies will add more assets to the the market this year, and divestments could help them advance energy transition goals -- if they can find buyers. RBC Capital analysts say it should remain a buyer's market for upstream asset sales. Royal Dutch Shell is considering the sale of part or all of its US Permian Basin shale holdings, reportedly valued at up to $10 billion. If sold, the proceeds could help accelerate debt reduction, leaving Shell in a stronger position to fund its transition (EIF Jul.14'21). Chevron, ConocoPhillips and Devon Energy could be tempted but must be cognizant of shareholder demands for cash returns over growth (related). Shell CEO Ben van Beurden notes that upstream assets account for a “very small minority” of Shell’s Scope 1 and 2 emissions and no Scope 3, so divestments would not make a real dent. On the other hand, Shell's refining divestments in 2018-21 are expected to slash Scope 1 and 2 emissions by over 50%. With oil over $70 per barrel, TotalEnergies boss Patrick Pouyanne said the French major is in no rush to offload its Canadian oil sands assets despite their high-carbon footprint (OD Aug.20'20). “It makes money, so I’m a happy shareholder," he said, adding that more buyers are likely to be found once an export pipeline between Calgary and Vancouver is built. The M&A outlook going forward also depends on the universe of buyers and their ability to tap constrained capital markets. Asset sales could create opportunities for investors less sensitive to environmental, social and governance risk and more focused on capital growth and dividend yield. But that could narrow the pool of buyers and force some creative dealmaking. Private capital -- private equity, hedge funds, sovereign wealth funds -- alternative investors, more traditional mid-cap and smaller E&Ps, and national oil companies will be among the critical buyers. Indeed, the largest international deal in the second quarter was Abu Dhabi sovereign investor Mubadala’s $1 billion agreement for a 22% stake in the offshore Israeli Tamar gas field. RBC thinks US majors could become buyers of upstream assets if "market disconnects and depressed valuations” present the right opportunities. Commodity traders such as Trafigura, Vitol and Mercuria-backed Tailwind Energy have also seized the upstream M&A opportunity (PIW Jul.2'21). Msimang expects to see more shared-risk deal structures, more vendor financing and deferred consideration structures, and more deals incorporating the allocation of decommissioning liability. BP and Eni say they will continue to seek country-specific opportunities to merge more marginal cash-generating upstream assets, as they have done together in Angola and separately in Norway (PIW May28'21).