While the overall number of oil and gas deals remained relatively flat between 2016 and 2017, there was a significant drop in deal activity with each successive quarter in 2017. For example, onshore upstream transaction value declined from $46 billion in the first half of 2017 to $18 billion in second half of 2017. The decline in dealmaking seemed most notable in the Permian Basin, where upstream transaction value fell almost 90 percent, from $19.6 billion in the first quarter to just $2.6 billion in the fourth quarter.

Many investors have demanded more financial discipline with a focus on shareholder returns, as opposed to production and acreage growth, and there are signs the industry is responding, as some analysts are projecting companies will generate free cash flow for the first time since the downturn. The industry appears to be reaching an inflection point where improved industry fundamentals alongside a plethora of available private equity capital suggest another round of dealmaking may be on the horizon, particularly in the U.S.

In general, oil and gas companies seem to be in an increasingly healthier financial position. Most balance sheets have been strengthening, and the cost reductions achieved by domestic unconventional producers have seemed to stick, at least for the time being. The combination of productivity gains and cost reductions in major U.S. shale plays have resulted in break-even costs remaining 30-50 percent below early 2015 levels. It also helps that oil prices currently exceed $60 per barrel, as inventory levels have tightened, following an extension of OPEC production cuts through the end of 2018.

Industry consolidation increased in 2017, and not just in the upstream but in the midstream and oilfield services sectors as well. This trend could continue in 2018, as the domestic unconventional oil and gas landscape remains largely fragmented, and companies may seek opportunities to extract value through strategic mergers. This could be particularly true for companies in similar plays pursuing similar strategies, or those with significant contiguous acreage, so long as operational synergies exist. Depending on the level of portfolio overlap, some of the advantages of consolidation might include increased economies of scale in the form of better utilization of gathering and transport capacity; stronger leverage with oilfield services and midstream negotiations; and optimization of a completions strategy across a larger number of wells – all potentially leading to lower capital and operating costs and more productive assets.

One example in 2017 was EQT’s acquisition of Rice Energy. The $8.2 billion deal combined two companies’ large Appalachian gas-focused holdings. This deal also increased the combined company’s contiguous acres, not just total net acres, which could allow for longer laterals, more effective pad positioning and better optimized use of midstream assets. Additionally, the company has publicly indicated that the deal boosted per-well returns by more than 50 percent via operational efficiencies, better market access and the sharing of data and best practices. This logic is likely not limited to the Marcellus or Utica. We could see companies pursuing similar transactions in other major shale plays like the Permian, SCOOP/STACK, Eagle Ford or Haynesville.

The oilfield services sector has recently seen a wave of consolidation, as many companies rationalize capacity and adapt to a shifting market, both internationally and in the U.S. For example, after years of reduced investment in the sector, M&A may be a more effective way to meet growing demand for equipment and services, particularly for those targeting domestic shale plays. That trend may continue in 2018, especially for onshore well construction and completion services, as the increasing number of drilled but uncompleted wells likely indicates the need for more capacity in completion services. This could continue to drive deal activity related to pressure pumping and necessary completion products like sand.

The oilfield services sector is still working through challenges. While many companies are engaging in transactions to increase capacity in regions like West Texas or Appalachian, other companies competing in offshore markets continue to face a weak contracting market with excess rig availability and limited deepwater activity. In that case, M&A seems to reflect the overcapacity facing the market, causing some companies to rationalize capacity and shore up balance sheets.

Another area for potential investment could be in technology, as the industry embarks upon a digital revolution that has contributed to efficiency gains across the value chain from procurement to human resources and back-off services. As an example, Quantum Energy Partners, an energy-focused private equity firm, recently invested in RigUp, a digital platform that connects service providers with buyers in the oilfield, and in Premium Oilfield Technologies, which engineers and manufactures technologically differentiated products used in drilling and completion activities. For oilfield service companies competing for limited upstream capital, providing value-added services can be one way to stand out in a commoditized business. Not just during the downturn, but in the recovery as well.

Outside of consolidation, strategic divestitures drove transactions in 2017. The downturn may have reinforced the futility of retaining unproductive or non-core assets in order to reduce debt levels and/or focus on a handful of core areas. With relatively flat oil and gas price expectations, recent upward moves notwithstanding, many companies are choosing to focus on fewer regions or plays. As part of this strategy, we have seen many companies divest non-core assets, particularly in high-cost and more mature regions. Moreover, if a company has 40 or 50 years of drilling inventory, buying additional acreage at relatively high prices might not be a priority, and in fact it may consider selling the last 10 to 15 years, even if in a core area, to generate liquidity. This could generate deal opportunities for well-financed players with an appetite for smaller acreage packages.

Despite a range of industry indicators from global economic growth to oil prices improved over the course of 2017 and into 2018, dealmaking seemed to remain subdued last year. Consolidation likely figured prominently in a number of transactions, and to a lesser extent, divestitures as well, as many companies continue to reposition themselves. There could be a rebound in oil and gas M&A in 2018, as the fundamentals continue to improve, and companies optimize their asset portfolios with increased transactions across the oil and gas value chain.

Ray Ballotta is an advisory partner with Deloitte & Touche LLP and leads Deloitte’s Oil & Gas Mergers & Acquisitions Transaction Services practice.