North American M&A Activity, General Investment Picking Up in the Energy Sector

Increased M&A Activity

According to IHS Herold’s latest merger and acquisition (M&A) Insight Transaction Review, the second quarter of 2010 has seen the highest level of merger and acquisition activity in the North American oil and gas sector since autumn 2008, suggesting a strong rebound and upward trend in transactions on the back of increased investor confidence. With a total of 57 transactions in the second quarter, M&A activity is up from only 35 deals during the same period last year and even above pre-recession levels of 47 agreements in the third quarter of 2008, a figure the market had reached again in the first three months of 2010. Equally, the value of these transactions has jumped from US$5.24 billion in the second quarter of 2009 to US$27.37 billion in the same period this year, exceeding the value of M&A transactions in the third quarter of 2008 by US$7.36 billion.

Moreover, North American deals accounted for 83% of the global oil and gas transaction count in the second quarter of 2010, indicating that the United States and Canada remain the centre of attention for international M&A activity. Transactions have largely focused on asset sales (62.5% of the total transaction value for North America in the second quarter) rather than the acquisition or mergers of entire companies. Asian players and IOCs have shown particular interest in unconventional oil and gas acreage. Out of the 10 largest transactions that were announced in the second quarter, with a combined value of US$20.36 billion, 37.5% were asset sales to Asian NOCs. The largest acquisition was ConocoPhillips’ sale of a 9% stake in Canada’s Syncrude joint venture to the Chinese Sinopec for US$4.65 billion, announced on 12 April, while state-owned Reliance India Limited’s (RIL) interest in U.S. shale gas development lead to the takeover of acreage worth more than US$1 billion from Pioneer Natural Resources in June (see Canada: 29 June 2010: Canada Approves Sinopec's Bid for ConocoPhillips's Stake in Oil Sands Project and United States: 5 August 2010: Reliance Eyeing Acreage in Marcellus Shale in U.S. and United States: 13 August 2010: Shale Development Faces New Challenges in U.S.).

Sources: IHS Herold M&A Insight, Transaction Review, Upstream Snapshot, 12 July 2010.

Energy Investments Rediscovered

In addition to the recent spike in M&A activity in North America, fresh capital has come from other sources in the second quarter of 2010. With oil and gas companies and assets undervalued in the aftermath of BP’s oil spill disaster and stable energy prices, hedge funds and private equity investors have found a new appetite for spending in the energy sector. Kohlberg, Kravis and Roberts & Co., for example (after cashing out its minority investment in Marcellus Shale-focused privately-held East Resources and realising a huge profit from Shell’s US$4.7-billion purchase of East Resources) invested up to US$400 million to form a partnership with Hilcorp Energy to develop its Eagle Ford Shale acreage. Large-scale investor Carl Icahnreportedly built up his energy holdings throughout the first half of this year to reach a total of approximately US$1 billion, of which he invested US$350 million in convertible shares from Chesapeake Energy Corp., the leading U.S. independent shale gas producer. At the same time, Mr. Icahn’s hedge funds invested an additional US$929 million in energy stocks in the second quarter, according to Bloomberg.

Private equity is committing even more funds to the energy sector, even though the focus has been more on utilities so far in light of attractive opportunities in a still demand-challenged environment. On 13 August Blackstone Group LP announced a three-way transaction with Houston (U.S.)-based Dynegy, Inc. for US$542.7 million. The third party to the deal is NRG Energy, Inc. of New Jersey, which will pay Blackstone US$1.36 billion for four of Dynegy's gas-fired power plants in the states of Maine and California. With the acquisition of Dynegy, the private-equity heavyweight Blackstone will also take on around US$4 billion in debt, which brings the total value of the deal to US$4.7 billion (see United States: 13 August 2010: U.S. Blackstone Group Takes Dynegy Private and Sells Power Plants to NRG Energy). 

Another private equity firm, Energy Capital Partners, has reportedly exceeded its goal of raising US$3.5 billion for its second energy fund by US$840 million, as investors seem to regain confidence in recovering industrial demand and the potential for a future rise in electricity prices. The fund focuses on power generation and transmission assets as well as gas pipelines. Accordingly, Energy Capital Partners II acquired three power plants on the U.S. east coast and a Texas gas pipeline currently under construction, among other investments.

Moreover, Asian interest in the North American energy sector has also come from institutional investors. According to IHS Herold’s latest M&A Insight Transaction Review, sovereign wealth fund China Investment Corp. has committed more than US$2 billion in Penn West Energy’s Canadian oil sands assets and Chesapeake non-voting convertible stock.

Outlook and Implications

The strong rebound in North American M&A activity in the oil and gas sector, along with asset deal pricing rising in the second quarter of 2010, reveals increased levels of investor confidence in the energy market albeit slow economic recovery and continued uncertainty about the prospect of tighter regulation of U.S. deepwater exploration and development. Investors are realising opportunities as credit markets begin to loosen up and currently undervalued targets in North America seem to offer favourable returns from undeveloped resource growth, which has become economically viable only recently following technical advances in drilling. Moreover, deals involving utilities or unconventional assets and producers are favoured by investors over offshore projects at the moment due to pending legislative changes following the Gulf of Mexico spill and the perceived ensuing risk and higher costs related to tougher regulation. Asian companies have been particularly prominent in the second-quarter unconventional transactions for different reasons. To them, North American unconventional resources present attractive long-term prospects, an excellent cash outlet for affluent players, and most importantly, an opportunity to build up valuable expertise for domestic shale gas development.

At the same time, North American independent oil and gas producers are streamlining their portfolios by divesting stakes in undeveloped resources in an effort to reduce debt or fund development efforts, or adding assets to their core activities as they spend cash held back during the recession, which simultaneously frees up acreage for IOCs and foreign interest. The trend of continued growth in the North American energy M&A market is expected to go on into the second half of 2010 and is likely to be crucial in the accelerated exploitation of unconventional resources, which are more expensive to develop than conventional oil and gas. Apache’s July acquisition of BP assets in the United States, Canada, and Egypt, worth US$7 billion, supports the optimistic outlook for the rest of the year (see United States: 21 August 2010: Apache Strikes US$7-Bil. Deal to Buy BP Assets in U.S., Canada, and Egypt). This phenomenon might even intensify if the U.S. Congress decides to extend the offshore drilling moratorium or raise exploration and production costs significantly through stricter safety regulation and more comprehensive, i.e. time-intensive, environmental assessments of deepwater energy projects.