A 10-Year High

By nearly every measure, 2012 was a banner year for mergers and acquisitions for North American exploration and production companies. Myriad factors—the hunger of private-equity firms and foreign buyers, the stability of energy prices, the lure of unconventional resources and the fear of rising taxes—combined to give companies extra incentives to reshuffle assets or buy out entire entities. Those factors are expected to drive additional deals throughout 2013.

The surge in activity was not limited to North America. A recent report from Bernstein Research indicates that since 2005, M&A activity has averaged $150 billion per year, even as oil prices have doubled over the same period. Last year, however, global M&A activity surged to a record $260 billion, an all-time high if the figures are adjusted for inflation. Asian national oil companies (NOCs) again took the spotlight as active buyers. They continue to boost production and seek reserves as their economies show a growing need for energy supplies. They remain aggressive in their desire to acquire overseas oil and gas assets.

In fact, last year was a record year for Asian buyers, with more than $60 billion in deals completed. This includes the $15-billion acquisition of Nexen Inc. by CNOOC Ltd. approved in December (but not yet closed).

That deal was the largest overseas oil and gas deal by a Chinese company.

Most observers expect additional deals from Asian oil and gas companies, as oil and gas consumption in Asia continues to rise, putting additional pressure on these companies to lock in reserves globally.

Drew Koecher, a partner with KPMG LLP who leads the firm’s energy transaction services, expects to see more foreign investors, including Asian NOCs, buying into North America. Those deals, however, will probably not occur on the same scale as the Petronas and CNOOC deals approved in the fourth quarter—both of which involved Canadian assets.

The unconventional

One of the reasons Asian NOCs are attracted to North America is the lure of unconventional resources. Partnering with a local operator who needs capital is one effective way to crack the shale code, take that technology home and apply it in other areas of the world. As a result, M&A transactions in unconventional re- sources have risen dramatically since 2007, when total activity in unconventional resources was about $14 billion. By 2012, the total rose to $65.5 billion, according to IHS Herold.

International buyers' stake in overall transaction value in North American onshore M&A activity generally leveled off in 2012, but domestic buyers helped to push overall transaction value to a new high.

Some clear global trends have emerged during the past five years. In the early days of unconventional development, around 2007 and 2008, U.S. independents took the lead and focused on gas shales. By 2009, with natural gas prices plummeting, there was a major shift to oil shales. In addition, the majors and international oil companies started moving their activity back onshore, according to Bill Marko, managing director of Jefferies & Co. Inc.

Companies with good-quality assets in unconventional plays, liquefied natural gas (LNG) or deep water in strategic locations will likely be looking for partners. North America, and in particular British Columbia, will continue to be the focus of asset deals this year. The potential for energy from unconventional sources will likely play an important role for three decades and require more than $2 trillion in capital to fully develop—and mergers and acquisitions can be an important source of capital. That level of investment breaks down to an average of $70 billion in capital needs every year for the next 30 years.

Marko said the industry has undergone a major transformation since technology allowed producers to “crack the shale code,” and that transformation has also affected the amount of M&A activity, which has generally risen since 2007.

“When all this started, we asked ourselves how do we get in the middle of the deal flow and help companies raise the money necessary for these world-class-sized developments,” he says. Since 2007, more than $500 billion has been raised by North American E&P companies. A large portion of that, about $297 billion, came from asset sales. Traditional debt accounts for $112 billion of that total, while upstream companies have issued an additional $74 billion in equity during the past five years, Marko says.

As a result of this activity, the North American onshore business is strong enough to support $100 billion of deal flow per year. In 2012, the total reached a record activity of $116 billion, about $40 billion of which came from international buyers, based on statistics from IHS Herold. Of the record activity seen in 2012, $41 billion was for deals in Canada and $72 billion was in the U.S.

Private equity

By 2011, the capital markets and private-equity players had stepped into the game, seeking return on unconventional resources. In the meantime, the percentage of oil-focused deals rose gradually until, by 2012, 84% of all M&A deals were in oil. “The internationals, majors and private equity are now paying attention to the shales,” Marko says.

Private-equity firms were also major players in 2012 and KPMG’s Koecher says they will remain active in 2013. Many of the major funds—KKR, Natural Gas Partners, Riverstone Holdings, First Reserve Corp.—were active participants in the energy market in 2012 and will remain busy in 2013. “All of them have raised significant funds and should continue to be active in 2013,” he says.

The sharp discrepancy between oil and gas prices has made some fields more profitable than others, and the M&A market is hot in any strategic area. Buyers are keen to get into oil and liquids-rich areas and have limited interest in areas of dry gas, Marko says. Meanwhile, sellers in areas that contain dry gas or costly formations to develop will likely have trouble finding a buyer.

The most profitable areas to drill lately include the wet Utica, Marcellus (southwest Pennsylvania and West Virginia), wet areas of the Eagle Ford and the Granite Wash. On the other end of the spectrum are predominantly dry-gas areas, including dry Eagle Ford, Haynesville, Barnett and Woodford. “Not surprisingly, liquids-rich plays tend to have higher returns than gas rich plays. The deal flows have clearly become more liquids-rich,” Marko says.

The flurry of deals last year, and the expecta- tion that 2013 will also be an active year, poses some unique challenges to oil and gas operators. Simply purchasing an asset is not a recipe for success, Marko says. Bolt-on acquisitions are attractive because they allow a buyer to take advantage of operating synergies. That said, the buyer has to be able to successfully integrate an acquired asset with its own operations. For corporate acquisitions, buyers also have the challenge of retaining skilled employees. “If you buy it, you have to be able to execute,” he says.

Another major trend seen throughout 2012 is the shift away from corporate deals in favor of asset acquisitions. Bernstein Research reports that the M&A wave of the 1990s was marked by large corporate mergers, but the recent activity in 2012 was fueled primarily by asset deals. Many upstream companies do not have the cash to develop deepwater or unconventional resource plays by themselves. Rather than exit entirely, they prefer to seek a partner. Meanwhile, the majors are looking to optimize their portfolios rather than make a radical change through large corporate acquisitions. Finally, the U.S., Canadian and Australian governments are more likely to approve asset deals rather than outright corporate acquisitions.

Outside the U.S., deals focused on gas and LNG are becoming increasingly prevalent over oil as gas takes an increasingly larger share in the overall energy mix, and LNG demand exceeds growth in demand for oil, Bernstein reports. Within the U.S., another trend is the ongoing interest in unconventional and deep-water assets rather than conventional assets. Many analysts expect additional consolidation of small-cap E&Ps, which have shale acreage or deepwater oil and gas discoveries but insufficient capital to develop them.

Political stability

Canadian onshore M&A made a significant jump in transaction value in 2012, while U.S. onshore deals held steady.

KPMG’s Koecher says the relative stability of the North American market is another reason for the active year in 2012. Despite the sharp political rhetoric surrounding the desirability of LNG exports, the U.S. and Canadian energy markets are generally very stable, a factor that underpinned M&A activity in 2012.

“Relative to the global stage, we have a politically stable environment,” he says. “Overall, the U.S. remains a very viable market for global participants.”

North America remains a resource-rich environment in a world that increasingly wants and needs access to those resources. A large part of the M&A activity is driven by the access to those resources, including the Canadian tar sands and U.S. unconventional sources. These will continue to attract the attention of foreign participants and fuel M&A activity in the future. “We really haven’t begun to exhaust the potential resource space for North America,” Koecher says.

The possibility that the North American LNG market could open up is propelling additional interest in the M&A market. “That prospect could open up possibilities in the long run,” he says. About 18 companies have filed for permits to export LNG, but so far, only Cheniere Energy Inc.’s facility in Sabine Pass, Texas, has received conditional approval. Sumitomo Corp. and other Japanese firms are keenly interested in the possibility of securing LNG supplies from the U.S.

Two major deals in the fourth quarter reflected an unexpected trend: the emergence of new kinds of buyers. Phoenix-based mining giant Freeport-McMoRan Copper & Gold Inc. plans to buy Houston-based Plains Exploration & Production Co. for about $6.9 billion in cash and stock. The deal is part of a plan to diversify its operations.

“As a deal in terms of sheer value and scale, it skewed the data for the fourth quarter,” Koecher says.

In addition, Encana Corp. signed a joint venture with an end user, Nucor Corp., to lock in gas supplies for the latter’s steel manufacturing operations. They will develop Encana’s gas assets in the Lower 48.

The Gulf of Mexico should also remain active, even if the data was skewed around two deals involving Plains Exploration in the second half, Koecher says.

A few risks

Although multiple factors bode well for an active M&A year, Koecher points out some risks. A general economic downturn, either in North America or in China, could throw a damper on deal flow. Continued uncertainty about environmental policies set by the U.S. Environmental Protection Agency and the lack of a clear Washington-led energy policy for hydraulic fracturing could also slow deal flow. In addition, further political gridlock and continued delays around pending LNG permits might force some buyers to delay prospective deals.

Several factors made the fourth-quarter 2012 one of the busiest in years. The number of deals in the U.S. oil and gas industry reached a 10-year high during the quarter with 75 confirmed deals, according to PwC U.S. During the final three months of 2012, total dollar value reached $56.2 billion, marking the second-highest level seen in 10 years (behind the $79.1 billion total deal value seen during fourth-quarter 2011).

Overall deal volume globally for full-year 2012 hit a 10-year high, with 204 transactions for deals valued at more than $50 million, representing $146.2 billion.

“M&A activity in the U.S. oil and gas sector was extremely robust in 2012, with the vast majority of that activity happening in the final three months of the year as many deals got pulled forward due to the uncertainty surrounding the fiscal cliff,” says Rick Roberge, principal in PwC’s energy M&A practice.