Historically after oil prices have taken a dive, driving down the price of oil stocks, a boom in merger activity follows. Weaker companies pair up with stronger ones in order to survive in some fashion, and stronger companies buy weaker ones because that’s a relatively cheap way to increase reserves and production.
Royal Dutch Shell’s $70 billion takeover of the BG Group (BRGYY), announced last week, is an example of this synergy. Shell (RDS-A) gets a bigger stake in the natural gas market, where it wants to expand, at a time when oil prices remain about half of what they were a year ago, while BG gets a 19% stake in the new, combined company, and, according to CEO Helge Lunch, becomes better positioned to “develop growth projects” already in its portfolio.
But it may be too soon to say if many more merger deals in oil and gas will be done this year.
A recent Brunswick Group survey of bankers, lawyers, private equity investment managers and analysts specializing in the energy sector found that although more than half of the respondents expect increased M&A activity in the sector this year the forecast wasn’t shared by all players. Sixty-eight percent of analysts and investment managers expected more M&A activity, but only 20% of bankers and lawyers did.
Melinda Yee, who leads Deloitte’s Oil & Gas Merger and Acquisition Transaction Services practice, says Deloitte “has been anticipating more consolidation” in the oil and gas sector but the stats for the first quarter this year show activity is down for prior years dating back to 2009. She “doesn’t expect an avalanche of deals” this year, though more are expected.
Valuation has been holding back deals, according to Lee and other investment bankers and analysts. Buyers and sellers are seen far apart on price.
What happens next will depend upon the individual parties, especially the sellers, says Yee. “They may be fine with debt loads today. But as they look to the future if oil prices don’t increase, that debt may have more of an impact on pricing and bottom-line results.”
Shell’s acquisition of BG values the gas company (formerly known as British Gas) at a premium of roughly 50% to its closing price on April 7, the day before the deal was announced. The deal also assumes a Brent crude oil price of $67 per barrel in 2016 rising to $90 per barrel between 2018 and 2020. Brent, which is extracted from the North Sea, is currently trading near $58 per barrel – about $5 more than the price of U.S. West Texas intermediate (WTI) benchmark.