An uptick in deal activity, including from private equity and divestments from larger players, pressure from regulation and environmental policy, and more: our Calgary oil and gas team responds to some of the key industry issues that will impact oil and gas in Canada in the year ahead.
A Guarded Optimism
Increased M&A activity is expected in oil and gas in the year ahead as industry players seek to increase cash flow, reduce costs and bolster balance sheets But while there are certainly reasons to be more optimistic about 2017 than 2016, the industry still faces considerable challenges on a number of fronts. This optimism—albeit very guarded optimism—and the existing challenges facing many companies may well both help to drive an increase in M&A activity in 2017.
Evolution of E&Ps
E&P companies looking to make opportune investments in 2017 will have to contend with many of the same issues as existed in 2016, including low commodity pricing, market access issues and reticence by sellers to part with crown-jewel assets, and consider new factors such as how a Trump administration’s policies may impact the investment climate in the Canadian oil patch.
On the senior E&P side, there has been significant transactional activity resulting from global divestment programs as the majors rationalize portfolios and shed non-core or less profitable assets. We are seeing some of the large divestitures come to fruition. These headline deals often involve legacy assets and can take years to execute, with significant regulatory hurdles. Drivers of these deals are not only acquisition price, but also reducing residual liabilities, transitioning the workforce and maintaining a good corporate reputation.
E&Ps will have to consider new factors such as how a Trump administration’s policies may impact the investment climate in the Canadian oil patch.
As a prominent example, Shell announced plans to divest of US$30bn in assets globally to deleverage after its US$54bn acquisition of BG Group. In Canada, this has included the 2016 sale of shale oil and gas assets to Tourmaline Oil and the sale of offshore interests to Anadarko, as well as halting or deferring commitments on certain capital intensive projects.
In March 2017, Shell announced the US$7.25 billion sale of most of its oil sands assets to Canadian Natural Resources in a joint deal that also involves Shell and Canadian Natural buying Marathon Oil's 20 percent stake in the Athabasca Oil Sands Project. ConocoPhillips is another international major pulling away from Canada with its recently announced sale of oil sands and natural gas assets to Cenovus for US$12.74 billion.
Meanwhile, junior E&Ps have found it extremely difficult to access capital for the development of international projects in a low commodity price environment and, if they can get equity finance, it is very dilutive at depressed prices.
These international E&Ps have high G&A due to structuring and staffing in multiple jurisdictions, more complex public disclosure and compliance costs, often with added risks related to currency fluctuations, uncertain pricing markets and unique challenges on the operations side. Many juniors have been forced to transact and consolidate. We have seen companies pursue creative partnerships and asset deals to attract the capital needed to meet commitments and advance projects.
Growing Private Equity Interest in Oil and Gas
Private equity has continued to find successful opportunities to deploy capital in the Canadian energy industry while capital markets have remained relatively constrained for many industry participants during the low commodity price cycle. There is a general consensus that there will be a recovery in the Canadian oil and gas industry supported by relative oil price stability above US$50/barrel and political support for pipeline projects to address market access concerns. As such, conditions are expected to be conducive to strong levels of M&A and investment activity in Canada’s upstream and midstream sectors. This continues to be a trend from the latter half of 2016 when senior Canadian producers were actively consolidating upstream assets; a number of significant midstream infrastructure transactions were completed; and activity in the oil sands sector significantly increased. Private equity fundraising has outstripped investment in Canadian oil and gas over the past few years. And there are significant amounts of capital looking for opportunities at an attractive part of the industry investment cycle from a valuations standpoint.
There is general consensus that there will be a recovery in Canadian oil and gas supported by relative oil price stability above US$50/barrel and political support for pipeline projects.
Private equity has been active in all areas including acquiring distressed assets through junior and mid-cap E&P restructurings and partnering through investment in both start-up management teams as well as senior issuers.
Midstream infrastructure assets continue to provide monetization strategies for producers and attract investment from both financial buyers and well-capitalized strategic buyers. As industry conditions continue to improve, consolidation in the oilfield services sector is also expected.
Responding to Regulation
That Canada has an abundance of natural resources is beyond doubt. However, Canada’s commitment to the development of energy infrastructure has been uncertain. The recent approval of Trans Mountain by the Canadian government and the continued support for LNG development exhibited by the B.C. government are critical signals for attracting offshore investment dollars in 2017 and beyond.
But there is no question that the federal government’s increased focus on environmental stewardship has and will continue to place pressure on the oil and gas industry. Our clients face increasing uncertainty and therefore risk regarding facility approvals, costs and future growth. Some provinces are also focused on climate change. Alberta, for example, has embarked upon an aggressive climate change initiative of its own. Industry players will be called upon to be forward thinking and innovative as they attempt to grow, compete and satisfy investors’ return expectations.
For more on what lies ahead for oil and gas this year, read our in-depth report Canadian Oil and Gas 2017 Outlook, where we analyze the results of a survey of over 100 oil and gas players on what they anticipate for 2017.
Against the current backdrop of rapid economic and political change, the art of adaptation is more important for business than ever.