By Emily Moser, Hart Energy

For much of 2015, corporate M&A has taken a backseat to smaller acquisitions while overall values and transaction numbers activity has remained in the basement.

Nonetheless, industry watchers expect a bump in A&D activity from bankruptcies and core restructurings in 2016 as countless companies continue to be battered from low commodity prices. Many predicted the same thing in 2015, but instead only a slow trickle of companies filed for bankruptcy so far.

Keith Buchanan, managing director of KeyBanc Capital Markets, told Hart Energy a similar pace of bankruptcies will continue into 2016 with little surprises.

"I think if you do a screen on the companies that are strained on liquidity and leverage, you can pick the obvious candidates that might be out there," said Buchanan, who is also head of KeyBanc's oil and gas group.

One thing is certain—the oil and gas industry has another challenging year ahead of them.

The industry will enter 2016 challenged by oversupply and low prices and it will remain that way for most of the year, Buchanan said.

For the most part E&P companies have become their own worst enemy.

“They’re drilling wells faster, cheaper and finding more reserves with each well,” he said. “Even though the rig count is down they’re much more productive with fewer rigs.”

Hart Energy: What’s your thesis regarding oil and gas prices in 2016?

Keith Buchanan: I think 2016 is going to continue to be a challenging environment for both oil and gas prices due to persistent oversupply.

Gas has a little bit additional headwind because of weather patterns. We’ve had a strong El Niño weather pattern this year, which has led to warm weather on the East Coast and low gas prices in the near term. And I think gas is going to continue to be a challenge due to oversupply and lack of demand.

On oil it continues to be oversupply as well. Although there is starting to be some positives at least developing in the oil market that might lead to some better outlook in the back half of 2016. Supply is starting to reduce, but we still have too much storage and not enough demand to take up that extra supply.

And again, I think the industry is a bit of a victim of their own successes. They found ways to find oil and gas very efficiently and in large quantities and that sort of led to this problem we have today.

But I think overall it’s going to continue to be a challenged environment for both oil and gas prices next year.

HE: What do you see happening in the M&A arena during 2016?

KB: The answer on M&A activity is what are prices going to do and are they going to continue to be volatile.

I think there’s a pretty strong correlation between volatility in oil and gas prices and M&A activity. When times are volatile, M&A activity is less. That’s what we saw earlier this year and that’s what we saw back in ’08-’09. When and if prices do stabilize I think we’ll see more M&A activity.

It’s hard to predict the large corporate transactions. So far this year, there’s been a couple of really big transactions, but not much else. If you take those away the activity level is way, way down for 2015. There are still some pockets of strength. There’s still a lot of activity in the Permian Basin, whether it be Midland or Delaware basins, and I think that will continue.

But once prices stabilize then we’ll have a much better view on where asset values are and we’ll be able to see both buyers and sellers agree on valuation.

As we get into the first part of next year, I think some other companies are going to have to sell assets because that’s the only place that they can raise capital, because capital markets are largely shut down for most of the companies so they’ll have to sell assets … to improve their liquidity and try to fix their balance sheets.

HE: What’s your sense of how many companies out there are on the brink of bankruptcy or have the potential to seek bankruptcy protection?

KB: It depends on what happens in the capital markets.

In the spring of 2015 the capital markets came back fairly robustly and that allowed some companies to not necessarily fix, but at least improve their balance sheets to avoid a bankruptcy filing.

If the capital markets are not there and companies have no way to fix their problems then maybe a bankruptcy or a core restructuring is the right thing to do to eliminate the debt and right-size the company’s balance sheet so that they can operate going forward.

We’ve seen a fair amount of bankruptcies so far this year. Will we continue to see some more next year? Absolutely.

HE: What will that mean for distressed asset sales?

KB: I think asset sales may be the place where companies have to go to raise capital.

If the high-yield market continues to remain shut down for the low single B and worst credits, equity markets are largely closed except for the Permian companies then … they’ll have to sell assets.

Companies get distressed because usually their assets are not in the core of the core or in the best basins. Will there be a value or a bid for assets? Sure, it just may not be the price that they like.

I do think we’re going to see a pick-up in asset sale activity once we get some stability in commodity prices and buyers and sellers can really agree on what value is.

HE: What are your thoughts on private equity firms continuing to inject money into the industry at a point when many believe it’s time to slow up?

KB: There’s a lot of private equity capital that is sitting on the sideline either committed with a management team that is looking for their inaugural asset or they’re waiting to find a management team to back.

They’re going to be very prudent in their investment decisions and they’re going to back good management teams that are going to pursue quality assets and quality opportunities and try to make money for their investors. If they don’t think it’s the right time to invest at these prices, they won’t. But if they do think they can do it and make money they will.

What that might do is sort of prolong this lower for longer mentality and situation that we’re in because it’s another form of capital that is out drilling wells or working over wells to try to increase production from the asset base.

So I think it might prolong the downturn a little bit, but I don’t have any big concerns about private equity coming into the space.

HE: States such as Alaska and North Dakota are taking fairly dramatic hits in revenue and jobs as oil and gas prices sink. What effects to do you see spilling over into the rest of the U.S. economy if commodity prices remain in the $40 range?

KB: Lower commodity prices and lower energy prices are probably a net benefit for the overall economy.

It certainly impacts those that are active in the energy business especially on the production and drilling side. But I think the overall benefit for the economy is a net positive whether it’s lower gasoline prices, lower utility bills, gas or heating oil to make electricity, the transportation sector, all of those are going to benefit from lower energy prices.

Manufacturers that are dependent upon energy costs as an input, whether it be a feedstock for something they’re manufacturing or just energy to run their businesses, they’re all going to benefit from lower energy costs.

At the end of the day lower energy prices are a net positive to the U.S. economy. It certainly has some much larger negative effects for the direct energy industry.

HE: What about Houston’s economy?

KB: I think Houston is much more energy centric than the overall U.S. economy.

Again there’s lots of parts of the energy value chain from oilfield services, drilling and E&P companies, which are much more suffering because of the lower commodity prices. The refining and the petrochemicals sector that benefit from lower energy prices. Then the midstream guys are sort of in the middle and they are not hurting but not actually benefiting all at the same time.

HE: Further thoughts on what we will see in the New Year?

KB: I think companies just need to be prepared for another challenging year. It doesn’t look like commodity prices are going to return to 2014 levels in oil or 2012 levels on gas. We’ve been in a long term declining natural gas price environment for a while and oil has only been down a little over 12 months. Companies just need to be prepared to be ready for a challenged environment in 2016.