For land owners in the Permian Basin, these are exciting times. There has been a flurry of mergers and acquisitions (M&A) activity over the past several weeks as crude oil prices appear to have settled in the $40-50 per barrel range.

While onshore upstream M&A activity is on the rise, some clear trends are beginning to emerge. Financing constraints have played an important role in keeping down M&A activity since debt markets have effectively been closed to the industry until recently.

Access to capital and the ability to transact are more critical than ever before in the current environment. This has prompted independent onshore exploration & production (E&P) companies to tap equity markets that have been recently bullish on the sector.

In the first half of this year, independent E&P companies have raised in excess of $19.3 billion in spite of oil prices that continue to remain at depressed levels. While proceeds from such offerings have been used to reduce debt loads and strengthen balance sheets, healthier companies have and will likely continue to utilize proceeds to fund acquisitions in core positions.

 In fact, most E&P companies that have sold shares this year have publicly indicated they will use the proceeds to acquire acreage. Public markets have been receptive to this strategy with a major catch–investors are acutely focused on only the most viable and cost effective locations to drill, most notably the Permian Basin and the South Central Oklahoma Oil Province (SCOOP) and Sooner Trend Anadarko Basin Canadian and Kingfisher Counties (STACK) fields in Oklahoma, where results have shown that effective producers can deliver profitable rates of return in this current commodity price environment.

Producers’ renewed interest in the Permian Basin stems from its favorable characteristics relative to other unconventional oil basins. Its unique stacked play geology lends itself to high efficiency gains and well productivity, driving costs considerably lower than other regions on a per barrel basis. From a natural gas perspective, investment has flowed to the Haynesville field in Louisiana, where operators have reported encouraging well results and operating costs have fallen. The Haynesville field also benefits from lower price differentials, relative to Henry Hub in comparison to other natural gas basins, given its proximity to end markets (which also sets itself up as a prime source for LNG exports).

Although public independent E&Ps have been increasingly more active from an M&A perspective, they are certainly not the only game in town. While many traditional buyers have been capital constrained and forced to restructure their balance sheets in the face of more stringent reserve-based lending covenants, many private equity firms with billions of available capital have been busy funding management teams with sizable equity commitments, in some cases as large as $500 million-1 billion, with the potential to commit significantly more funds with future acquisitions. Again, many of these management teams are focused on acquiring core positions in the Permian Basin. 

Recent Permian valuations seemingly bode well for current landowners, particularly in the Midland and Delaware basins. For context, there were 13 publicly announced upstream transactions in the Permian Basin in the second quarter, which averaged $17,000/acre. The implied deal values per acre over the past two to three months have reportedly ranged between the high $20s to low 40s thousands per acre. For example, PDC Energy Inc. announced plans to buy two companies in the Permian Basin

The rapid rise in valuations is a windfall for current landowners, but it poses a double-edged sword for investors on the prowl in that finding “deals” will likely be increasingly more difficult if valuation levels sustain without consensus surrounding an expected rise in crude oil prices.

Two additional catalysts expected to drive M&A activity for the balance of 2016 and into 2017 are 1) the reported uptick in the quality of assets being divested by companies that need to restructure debt laden balance sheets; and 2) equity markets have rewarded independent E&Ps that announced plans to rationalize their oil and gas portfolios to focus on core assets, which has prompted asset sales. 

As of Aug. 31, 2016, there have been approximately 186 global bankruptcies in the oil and gas sector, of which 93 are producers. For buyers, assets that have gone through bankruptcy proceedings may be more appealing, because they usually emerge from the bankruptcy process unencumbered by liens, claims, and certain liabilities. Out of 136 announced deals for the first half of 2016 for the upstream sector, only three involved companies selling assets in bankruptcy. One explanation for the limited number of properties on the auction block offered by companies in bankruptcy is that those companies still doing business under court protection could be entering into pre-packaged arrangements with their lenders that restructure debt and limit asset dispositions. However, with 93 upstream companies in bankruptcy as of Sept. 2016, more assets are expected to come to market over the next year.

The oilfield services sector has been particularly hard-hit by the oil price downturn as this sector is most directly and immediately impacted by the cutbacks in activity by producers and the subsequent loss of demand for equipment, oilfield crews, and supporting services.

In general, M&A activity in the oilfield services sector has been muted, but consolidation in the middle-market could be on the horizon, particularly if financing markets cooperate. Cost synergies have become a main focus for transactions, while revenue synergies no longer motivate deals. The current focus on cost-cutting in the sector has made developing new technology more difficult with cutbacks in R&D budgets. As a result, there has been more focus on acquiring existing technology to penetrate new markets.  Consolidation in the middle-market sector is on the horizon if financing markets are willing to cooperate.  

As the industry enters the third year of low prices, signs are beginning to emerge in the midstream market, and M&A activity has also been impacted. First, TransCanada Corp. (NYSE: TRP) acquired Columbia Pipeline Group Inc. (NYSE: CPGX) in March 2016, which was most recently followed by Enbridge’s massive deal with Spectra Energy—a deal that has made splashy headlines. This is continuing a consolidation trend amongst large midstream companies that are utilizing their scale to seek operational synergies during this downturn while also recognizing that large-scale organic growth has become increasingly more difficult. Lowering costs and costs of capital are the primary impetuses behind expected consolidation according to most industry respondents.  

Overall, M&A deal-making has had a noticeable pick-up over the past several weeks and months. Cautious optimism for a recovery in M&A activity is returning.

Editor’s note: Certain data and statistics contained in this article were obtained from various sources, including GlobalData, Wood Mackenzie, Haynes and Boone LLP and 1Derrick Petroleum Services Mergers & Acquisitions.

Ray Ballotta  Jr. is a partner, M&A transaction services at Deloitte & Touche LLP, providing buy-side and sell-side M&A transaction assistance to private equity and strategic buyers for domestic and international transactions. 

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