Energy companies have invested billions of dollars in exploration and production projects over the past few years on the assumption that oil would remain close to $100 per barrel. Oil and natural gas companies — particularly those taking part in the U.S. shale boom — borrowed heavily on that assumption, and bond buyers have snapped up more than $50 billion worth of junk bond offerings from them. Almost no one predicted that oil prices would then dive, however, and that this debt, and many of the companies themselves, would lose billions of dollars in value in a matter of months.
Brent crude and U.S. crude oil prices have both dipped below $50 per barrel, experiencing a 56 percent drop since June, and U.S. natural gas prices set a new two-year low last Thursday, falling below $2.80 per one million BTUs. Expectations for the duration of the low-price trend range from one month, from Organization of the Petroleum Exporting Countries secretary general Abdullah al-Badri, to three years, from BP chief executive Bob Dudley.
Now energy producers and service companies caught off guard by the precipitous drop in prices are scrambling to make debt payments and to cover their costs. Should the trend continue, the obvious result will be amended credit agreements, defaults and a rash of asset and company sales. Perhaps less obvious is the hunger with which some investment firms and rival energy companies are targeting the wounded firms. (See also “5 Reasons Why the Collapse in Oil Prices Is Not Bad for the Economy.”)
“I’m getting a lot of inbound calls from institutional investors trying to figure out what’s going on. A majority of them view this as potentially a very compelling investment opportunity,” says Jeff Eaton, head of global origination for fund-placement agency Eaton Partners in Houston.
It’s an opportunity on which some buyers, particularly private equity firms and healthier energy companies, have already begun to cash in. In the fall Houston- and Dubai-based oil field services company Halliburton bid $24.6 billion for Houston-based rival Baker Hughes, a pending deal that’s now valued at nearly $35 billion. Though both companies announced this week that they plan to cut thousands of jobs because of the price slump, the acquisition appears to be on track. (See also “Distilling Who Will Benefit from Falling Oil Prices.”)
Repsol, an integrated oil company based in Madrid, agreed in December to buy Calgary-based oil and gas exploration and production firm Talisman Energy in a deal valued at $8.3 billion.
In fact, whereas the fourth quarter of 2014 did see a drop-off in the number of energy deals — 299, compared with 422 in the fourth quarter of 2013 — total deal value jumped more than 35 percent year over year, from $75.8 billion to $108.6 billion. Meanwhile, rumors are circulating about possible sales of Houston-based oil and gas drilling and production equipment provider National Oilwell Varco, and London-based BP, which continues to deal with the costs of the 2010 Deepwater Horizon spill in the Gulf of Mexico.
Buyout firms and distressed-asset investors such as Carlyle Group, Blackstone Group and Apollo Global Management are finding in the current environment both a way to get deeper into a market with what they hope is a long-term upside and an opportunity to fill a void left by banks. Speaking to reporters at the World Economic Forum in Davos last week, David Rubenstein of Carlyle said distressed energy debt would be an attractive area of investment for his firm this year, noting that many companies will not be able to pay back their debt on the terms at which they borrowed.
As it becomes increasingly difficult to value energy companies’ debt and assets, traditional lenders will be rewriting existing credit agreements and avoiding new ones. Four months ago, an oil company hit by the initial downturn could simply issue debt. Now there’s a growing gap to be filled by savvy private equity firms, says Eaton.
Market players expect the deal flow of conventional M&A, as well as asset sales involving private equity, to ramp up in coming months, barring a major price turnaround. But it may take a few months for the environment to produce optimal conditions for those kind of deals.
“There’s going to be potential for a lot of M&A activity, but it’s going to depend on a couple of things: when prices start to come back ... [and whether] banks and private equity companies are going to force some sales,” says Jack Luellen, chair of Fox Rothschild’s energy and natural resources practice group in Denver.
The real wave of opportunity may still be a few months off, because value assessments by buyout firms and alternative-investment firms and target companies remain very far apart. When BP began selling assets several years ago, it wasn’t difficult to get the prices the company wanted. Now buyers are looking for significant discounts, says Rashed Haq, vice president at New York–based advisory firm Sapient Global Markets, pointing to the difficulty that Royal Dutch Shell, headquartered in the Hague, is having selling assets at what it believes are reasonable prices. “Toward the end of the last quarter and early this quarter, it’s gotten harder for [buyers and sellers] to come to a consensus,” says Haq, who operates out of Houston.
It’s not yet clear what will happen with BP, which has liabilities of more than $44 billion related to Deepwater Horizon and billions more at stake in ongoing federal proceedings and lawsuits. The company has seen its stock drop 7.9 percent over the past three months, reaching a low of $34.94 per share on December 15, down from $45.77 at the same time in 2013. CEO Dudley told reporters at the World Economic Forum that BP and other oil giants were likely to see “significant workforce reductions” as a result of the price plunge.
But where some may see red flags, others see an opportunity. Invesco Perpetual head of U.K. equities Mark Barnett recently told London’s Telegraph that he is continuing to build his position in BP despite its weak performance, banking on the assumption that its dividend is safe and that a turnaround is in the near future. Experts speculate that state-owned oil entities — perhaps in Qatar, Kuwait or even China — or even a high-net-worth individual may soon begin to show a similar interest.
The structure of any deal for BP would likely involve a good amount of stock, and Chris Pultz, head of merger arbitrage at New York–based alternative-investment manager Kellner Capital, expects that will be the case in a lot of upcoming transactions, as it has been in the Baker Hughes–Halliburton deal. “Unless they’re in a pinch, they’re going to want to participate somewhat in the upside,” Pultz says.
Though many companies are holding out in the hope that oil and gas prices will soon rise, those that can’t afford to wait, even after having unloaded assets, will find themselves becoming attractive targets for investment firms and companies, notably large integrated producers that have absorbed less of a hit from the price drop and can take the long view.
What these distressed sales will look like will depend on the parties involved, but Luellen expects that if the current trend continues through 2015, there will be big opportunities for those who can stomach the risk. Those opportunities may not emerge for several quarters yet, but if prices stay where they are, highly leveraged firms will eventually have no choice but to sell. (See also “Oil Crash Leaves Renewable Energy Shaken but Unbowed.”)
