Current Realities in the Oil and Gas Property Acquisitions and Divestitures Market
Riverbend continues to see a disconnect between buyers and sellers in the property acquisition market as the oil and gas industry begins to rebound from a significant downturn in revenues, activity and confidence in 2020 due to the impact of COVID-19 and the Q1 OPEC price war. For successful transactions to occur, sellers need to come to terms with the current state of the market (access to debt/equity capital, valuations, ESG, commodity prices, shale well spacing, “end of life”) and the value of their assets.
As we enter Q4 2020, we sense a coming time whereby rational “strike prices” on assets of size become more actionable and likely to actually find the closing table. Many existing and potential energy investors are taking a slower, more vigilant approach to investing, emphasizing patience, as the political landscape, global response to COVID-19 and world crude supply/demand continue to become apparent. Consumer confidence and OPEC’s impulsive decision making are other incremental factors that have traditional energy equity investors hitting the pause button, therefore piquing the interest of “new equity entrants.”
SPACs are coming to the overall market in great numbers, but few have targeted E&P or producing assets to date. We have recently seen a SPAC, originally formed for oil and gas acquisitions, pivot and close on a renewable (charging station) company acquisition. That said, capital intensive spaces that are particularly susceptible to commodity fluctuations, such as the upstream industry, must lean on private equity investors for encouragement, support and partnership. On the other hand, investors are “picking their spots” and/or wading cautiously into new capital formation and/or acquisitions and weighing risks and upsides with a growing lack of dry equity powder in the market. With most talking about an oil and gas market cycle over previous decades in these subdued times, today there is more discussion of a contrarian view of those confident of a demand recovery for fossil fuels.
Factors Shaping Capital Flow in Oil and Gas
Commercial banks and their changing (and slowing) financial support to the upstream oil and gas industry are another factor to consider as the transaction process evolves. This bank phenomenon is due to the rise in sensitivity of public and equity investors related to carbon capture, overall ESG mindsets and a string of loan losses in E&P-land. Additional aspects of the current commercial bank drivers and attitude include the year-to-date significant drawdown of commercial paper by the supermajors, adding to the bank sector’s exposure to oil and gas. This bank financing situation and, in most cases, a step-back, provides a unique opportunity for new, creative investors and/or private capital to propose alternative financing solutions and timelines.
In 2020, E&P bankruptcies have seen a significant increase, in part due to the aforementioned lack of support of the banks and the reduced borrowing credit against lowered asset valuations. However, the number of bankruptcy filings have been fewer than many expected at the onset of the pandemic/price war, and those corporations that have fallen victim to this year’s filings most likely had underlying financial issues heading into March. Another development worth noting is the increase in Chapter 7 filings, in which assets are liquidated, as opposed to Chapter 11, where a reorganization is structured. This creates a unique opportunity for energized, liquid private equity investors to obtain compelling holdings alongside management teams with experience and good track records. Those who have circumvented their financial demise have turned to alternative solutions and are pursuing protection and/or renegotiated arrangements with creditors to withstand the current environment. This area of the market will be very interesting to follow, and Riverbend is actively working through possible ideas as we enter into 2021.
Markets to Watch
Riverbend is active in all sectors of the acquisition space, inclusive of operated, non-operated, natural gas and mineral assets. The aforementioned market conditions and factors are impacting investment and transaction decisions in all of these markets. As “stay at home” orders have been released, and optimism slowly re-enters the market, the stage could be set for certain sectors within the space to rally back. The natural gas market in particular may be poised for an exciting 2021 as prices have strengthened due to reduced activity/production and changes in the electrical generation stack. Crude oil is another division to eye, with high base decline rates, reduced drilling and completion activity (CAPEX) and increasing worldwide demand. Many analysts are watching for a possible inventory crunch in the coming quarters, leading to escalating valuations. Most analysts are tracking U.S. (natural gas, oil) and worldwide (oil) inventory levels as demand recovers and, clearly, jet fuel (international travel) is a key center under pressure.
Without a significant adjustment in total cost structures (lower) and/or increased revenue generation (commodity prices), oil and gas ventures will be strained for cash flow and capital, likely requiring greater need in private capital support. Since commercial banks are trending to a lower loan “book,” by count and dollars, oil and gas producing companies need to position themselves as secure, prudent and free cash flow driven entities to attract private investors. Many existing public companies are already converting to distribution-oriented ventures with many more headed that way in 2021. Although debt and equity capital is scarce and concerns regarding ESG and supply/demand fundamentals are high, Riverbend expects to see the remainder of 2020 and 2021 bring unique acquisition and private investing opportunities to the table for those private equity groups that are well positioned with great equity and commercial bank partners.
Since the start of energy private equity (funds raised by G.P.’s to support the small cap E&P space) in the late ‘80’s, private equity became a significant participant in the oil and gas upstream space. Private equity firms became great in number as institutions (endowments, insurance companies, family offices, foundations) desired exposure to a growing segment of the market outside of merely investing in the oil and gas public equities. This role, 30 to 35 years later, remains essential, but is currently stifled with thoughts of a declining fossil fuel world and with energy only about two percent of the S&P 500.
The oil and gas market has withstood fluctuations since its inception, and Riverbend has experienced cycles since 2003. The current market provides Riverbend with opportunity. We remain encouraged for the next decade of growth and performance as we look to identify unique opportunities in the space. In a changing market, ultimately anchored by diligent technical subsurface reserves assessments, and land, accounting and commercial diligence, Riverbend has a very high degree of confidence to sustain and thrive through these times due to our culture and performance-based team and systems.