Despite last year’s outlook and positive trends, deal volume hit a five year low. Deal value fell overall across the sector with upstream showing the only increase. Although now moving to growth agendas which will drive deal activity, companies are recognizing the need to embed effective portfolio optimization practices to get the right type and mix of assets to secure mid-term growth while maximizing returns.
The stability that should have contributed to increased confidence in valuations and deal activity may also have affected perceptions of upside potential and downside risk, and reduced interest in moving assets from one company’s column to another. Uncertainty around the effectiveness of traditional portfolio reviews and future energy mix has also delayed the uptick in deal volume in 2017. However, replenishing project pipelines and a desire to take advantage of the best opportunities arising in 2018 is pushing companies to transform their portfolio reviews and deliver on their growth agendas.
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US$172.2 billion — Total upstream deal value increases 30% year on year
Upstream first quarter deals deliver a positive 2017
Moving into 2017 we projected a stronger upstream transactions market, rebounding from the worst year in recent memory, with oil price recovery and stability. This proved to be the case with deal value climbing 30% to US$172.2 billion, the second strongest performance in the last 5 years.
A key feature was a very strong first quarter which outpaced other quarters’ average deal value by more than 82%. Canadian players drove the first quarter result by aggressively managing pricing challenges from location differentials and heavy oil.
Although 2017 deal values were up substantially, deal counts were down by 19%, which resulted in the average deal value increasing from $111 million to $178 million. Management teams and their boards, particularly those with higher leverage, acted to improve balance sheets, high-grade portfolios and lower equity risk.
North America again led the way with US$94 billion in deal value in 2017 versus US$79 billion in 2016, representing a 19% increase. Key themes were Canadian oil sands consolidation under Canadian ownership, independents consolidating their core basins (primarily Permian, Eagle Ford, and Marcellus) and majors extending unconventional positions.
New for 2017 was the European resurgence which (excluding the 2015 Shell-BG deal) was the best performance in over 5 years at US$27 billion.
Key themes we expect during 2018 include:
- Proven North American shale players that consistently generate cash returns gaining more and lower cost capital to consolidate positions in basins where they have an operating advantage.
- Focus on moving offshore and deepwater cost curves can lower cycle times to access higher rate conventional resources – anticipating that host governments with advantaged resource positions will reconsider their fiscal regimes.
- PE activity to increase as several players seek to ‘cut their losses,’ release stranded capital and exit positions taken before the downturn, while other PE players seek creative deals.
- The majors to continue to divest non-core late life assets, and are able to assume additional debt to focus on developments in US and Latin America deal opportunities.
US$84 billion - Total midstream deal value decreases 43% year on year
Moves by Master Limited Partnerships drives midstream
As forecasted, midstream players continued the trend toward capital structure reset during 2017, looking inward to lower capital costs, increase capital access and improve balance sheets for expected longer-term trends for infrastructure expansion. Even with the forecasted oil price increases, the commodity exposure and price declines since 2014 drove many leadership teams, especially those under Master Limited Partnership (MLP) structures, to take action.
A very interesting feature for 2017 was the prominent MLP capital structure reset. Nearly US$53 billion (or 63%) of midstream transaction value were corporate-based General Partners increasing their position or acquiring all of the limited partner interests.
Midstream companies also focused on “strengthening existing positions.” Over US$14 billion in transaction value were driven by companies acquiring competitors operating in the same basins where leadership believes growth and margin opportunity will continue. Private Equity players also continued seeking positons and assets in advantaged midstream infrastructure, driving nearly US$7 billion in transaction activity.
2017 was clearly a challenging year for midstream players as they dealt with capital structure challenges in the face of increasing investment requirements and E&P customer pressures. 2018 should see the industry sector return to its fundamental business connecting producers and products to markets. We anticipate a stronger deal market as commodity prices strengthen and drilling and development activity unfold. Finally, the continued preference trend toward cleaner energy will drive interest in natural gas and LNG. In the longer-term we see more nations pressing for fuel oil power generation conversion to natural gas, which will drive LNG development infrastructure.
US$59 billion - Total downstream deal value decreases 12% year on year
US dominates downstream deals
Similar to the past five years, the US and Europe continue to have the highest levels of activity in the downstream sector, despite a decline compared to prior years. Themes driving global downstream transactions during the year including:
- US companies dropping down assets into MLPs
- NOCs acquiring assets in markets outside of their core geographies
- International oil companies selling non-core assets
- Investment funds and pensions investing in distribution assets
- Trading companies buying distribution and retail assets
Looking forward, we expect to see a continued focus on transactions in the downstream globally as companies look to further balance their portfolios across the value chain to take advantage of attractive economics and look for opportunities to grow. In particular, NOCs and major oil companies have expressed their desire to grow in refining and petrochemicals to take advantage of low natural gas and demand growth fundamentals in markets like North America and Asia. There is also a renewed focus on retail in certain markets as companies look for opportunities to access attractive margin pools in convenience retailing and as a hedge against declining fuel margins.
US$28 billion - Total OFS deal value decreases 35% year on year
Fragmented oilfield services under pressure
Throughout 2017, operators have been able to move on from focusing on survival to focusing on returns. However, as capital has been diverted to those basins and plays which are either inherently cost advantaged or show a greater amount of capital flexibility, the oilfield services market, which is still highly fragmented, has continued to experience significant pressure. Generally the supply chain in the higher cost basins and the more asset intensive areas have had the hardest time, as unreliable demand and aggressive price competition have challenged both sales and margins. The oilfield services industry has responded with a range of actions, with notable cost reductions and the removal of operating cost and capacity out of the market.
M&A activity has picked-up meaningfully in 2017 and we expect this trend to further strengthen in 2018, supported by an expected increase in upstream capex spending and an improving oil price environment.
These are five key drivers of M&A activity in 2017, which we expect to continue to prevail in 2018.
- Value chain integration
- Economies of scale
- Increased access to capital markets
M&A activity will also come from portfolio optimization in 2018. With various contractors and service providers already planning divestments of non-core divisions, either as a direct result of M&A activity or as a continued move towards improving cashflows and returns on capital.