When the energy sector faces a severe existential threat as it currently is after the epic oil price collapse, the usual playbook is to resort to tie-ups in a bid to survive. Unlike other industries where M&A activity tends to correlate with economic activity in the broader market, crises in the oil-and-gas sector tend to trigger a wave of merger mania in response to low commodity prices.
For instance, the last oil bust of 2016 acted as a catalyst for the $60 billion M&A deal between energy giants Royal Dutch Shell and BG Group, Suncor Energy and Canadian Oil Sands, as well as a $35-billion proposed merger between Halliburton and Baker Hughes that eventually fell through.
In sharp contrast, the current year is recording a dramatic fall in M&A activity in the energy sector: An ominous sign that the oil and gas bust--the worst in history amid the dreadful COVID-19 pandemic-- has everybody freaked out.
In other words, bearishness in the sector has truly reached a crescendo.
A fresh report from Enverus (formerly DrillingInfo) has revealed that U.S. upstream M&A deals during Q1 2020 only amounted to $770 million, less than 1/10th the average deal amount recorded quarterly over the previous decade.
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The largest dollar transaction for the quarter was a deal by Alpine Energy Capital to purchase Approach Resources' Midland Basin assets for $193 million. Compare that to the $55 billion tie-up between Occidental and Anadarko or the $9 billion merger between Marathon Oil and Andeavor Logistics, both of which were consummated last year.
If M&A numbers for the next three quarters track Q1's trajectory closely, then 2020 could end up being the slowest year in the history of mergers in the sector.
Here's how Q1 2020 upstream M&A compares with recent quarters:
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The Enverus report reveals there are only ~$4.7B in upstream deals currently available in the market for sale, the majority of which are property sales in the Eagle Shale. Compare that to $92 billion in completed mergers for the oil-and-gas industry in 2019 or the average of $78 billion over the past 10 years. Mind you, practically all Q1 deals were closed before March, an indication that the widespread lockdown is having a terrible effect on business.
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The dearth of deals in a critical time such as this can mean several things.
First off, few companies are willing to conduct a fire sale of their assets given how badly valuations in the sector have tanked. The energy sector's valuation has been cut in half since the beginning of the year after the oil price crash, and could go lower if the oil price war between Saudi Arabia and Russia persists. Indeed, reports are emerging that some oil producers have begun including 'zero clauses' in their contracts as protection to avoid being forced to pay buyers in the event of oil prices sliding below $0 a barrel. You know that things have truly gone to the dogs when producers are seriously contemplating negative oil prices.
Second, it's too risky for potential acquiring companies to start buying cheap assets during times of massive volatility and uncertainty such as these. After all, nobody's even sure where the industry will be in six months, 12 months, or two years from now. Deep-pocketed companies would rather just sit on the sidelines and wait for the storm to subside before starting to hunt for prime assets for pennies on the dollar.
Third, a lot of M&A activity tends to be heavily leveraged, and not many energy companies have maintained healthy credit ratings in this bloodbath. Consequently, a lot have resorted to the junk bond market, where they will have to pay through their noses in due time thanks to astronomical yields.
Indeed, most companies, including those with relatively healthy balance sheets, would rather engage in activities with faster ROI such as spending and production cuts. In fact, this is exactly the trend we have been witnessing in the space.
U.S. oil majors including Chevron Corp. (NYSE: CVX), Devon Energy Corp. (NYSE: DVN), Marathon Oil (NYSE: MRO), Occidental Petroleum (NYSE: OXY), Cenovus Energy (NYSE: CVE) and Apache Corp. (NYSE: APA) have followed in the shoes of Europe's Big Oil including Royal Dutch Shell (NYSE: RDS.A), Italy's Eni SpA, French major Total SA and Norway's Equinor ASA (NYSE: EQNR) in announcing a raft of capex, share buybacks, and dividend cutbacks.
Chevron announced a 20 percent cut in its FY 2020 guidance for organic capital and exploratory spending of $20B to $16B as well as suspension of its $4B stock buyback program, in a strong response to the oil price crash but said the dividend program remains 'very secure.'
Devon Energy has gone on a spending-cut rampage, lowering capex twice in the space of a month by 45 percent. The company will slash spending by 29 percent in the current fiscal period and reduce drilling activity in a bid to preserve liquidity.
Meanwhile, Occidental Petroleum announced that it had slashed quarterly dividend by 86 percent to 11 cents from the previous level of 79 cents and lower 2020 capital expenditure from the earlier expectation of $5.2-$5.4 billion to a range of $3.5-$3.7 billion in a bid to safeguard its liquidity.
With so much uncertainty going in in the sector, you can't even blame companies with ample liquidity for not rushing out to scrounge on bargain picks of companies on their knees.
By Alex Kimani for Oilprice.com
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