Debra Villareal | Thompson & Knight LLP
As Warren Buffett once noted: “Writing a check separates a commitment from a conversation.” And more companies are writing checks this year as the energy sector has enjoyed robust merger and acquisition activity. The first quarter of 2014 saw the highest first quarter volume of energy mergers and acquisitions in more than a decade.
The strong start has been welcome news for the energy sector after the slump in merger and acquisition activity experienced in 2013. Deal flow slowed in 2013 partly because of the significant number of transactions completed in 2012. Concerns about changes in tax laws rumored to occur in 2013 encouraged some sellers to pull forward deals into the fourth quarter of 2012 that otherwise would have closed in early 2013. The tax changes did not occur, but the market remained quiet in 2013. Also contributing to the slowdown in deal flow in 2013 was the number of companies strategically choosing to concentrate their capital spending on developing existing acreage positions rather than acquiring additional assets. Globally, the industry saw a drop of 41percent in total deal value and 119 fewer deals in 2013 than in 2012.
After the 2013 doldrums, the first quarter in 2014 saw 43 transactions with values greater than $50 million closed, for an aggregate amount in excess of $19.9 billion. Exploration and production asset transactions made up the majority of this amount, with particular emphasis on shale plays in the Bakken, the Eagle Ford and the Permian. Buyers have been drawn to plays that are liquids rich, along with those that have developed midstream infrastructure and market access. Companies will continue seeking opportunities to acquire more liquids-rich properties to balance their asset portfolios, and to acquire properties adjacent to their existing acreage to bolster their holdings.
The favorable capital market has been a significant driving factor in activity, as capital remains fairly inexpensive and plentiful. Private equity involvement in the oil and gas sector remains high, with nearly $100 billion in private equity-backed management teams. In addition to funding companies that are pursuing deals, private equity firms are also helping feed the pipeline of deals for sale. Some private equity investors who are reaching the end of their common three-to-five year holding period for investments this year are electing to monetize their investments due to attractive market prices. The merger and acquisition activity in 2014 will remain influenced by the expectations of private equity firms.
The energy sector has also been buoyed by strong, stabilized oil prices. So long as oil prices remain at $80 per barrel or above, companies will continue to find a number of different plays to be profitable.
Foreign investment in U.S. energy slowed in 2013. There is indication, however, that even though the volume of foreign investment may have slowed, foreign investors remain interested in participating in U.S. shale plays, as they look for attractive investment returns, as well as opportunities to gain technological experience for shale development. Recently announced deals with foreign investors include a joint venture between Energy Corp. of America and China Shenhua Energy Co., China’s state owned coal company, to drill natural gas wells in the Marcellus, and the acquisition of ERG Resources LLC by Goldleaf Jewelry Co., a Chinese gold retailer.
Even with all of the positive elements in the merger and acquisition activity, there are a few counter-indicators. Some buyers and sellers have been unable to agree on prices, with sellers wanting value for probable and possible reserves, but buyers being unable to overcome the risk- adjusted evaluations for such reserves. Gas-weighted companies have shown little interest in adding further gas assets, so properties that are not heavily liquid remain relatively unattractive. Companies that would appear to be likely buyers remain entrenched as they exploit the significant opportunities from the properties they have already acquired.
Notwithstanding the downward indicators, the numerous upward indicators point to a continuation of strong merger and acquisition activity in the energy sector. Companies looking to supplement acreage positions and to balance their holdings with more liquid-rich assets, the favorable capital market, stable oil prices, and continued interest by foreign investors, will all help keep deals flowing through the end of 2014. Companies will continue to commit and will keep writing those checks.