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Against talk of fiscal discipline, analysts see groundwork for US oil, gas M&A

In the two years since the end of the price collapse that started in late 2014, oil and gas industry observers have been waiting for a sustained pickup in merger and acquisition activity. It has yet to happen, but that did not deter EY and Deloitte teams from projecting a rebound.

After a relatively quiet 2017 for M&As despite a busy first quarter, both consultancies are optimistic about dealmaking in 2018, even as one company after another stresses to shareholders that they will show fiscal discipline and live within their means.

EY said producers remain understandably gun-shy but pointed to a number of signs in recent months should help push M&A activity up in 2018. "A lack of blockbuster deals in 2017 highlights the industry's sense of caution in the post-downturn era. But buyer and seller expectations have been narrowing and a robust pipeline of actionable M&A opportunities is now available, underpinned by an increase in the oil price, decreasing valuation gaps and improving market sentiment," Brogan said. "We expect these trends to continue to prevail in 2018, with M&A activity flowing from portfolio optimization, increased access to capital markets and value chain integration."

In its projection of 2018 M&A activity, Deloitte said headwinds still exist for the M&A market but companies are more likely to be looking for deals that will supplement the existing strengths of their portfolio while putting noncore assets on the market.

"I still think investors are demanding financial discipline, so assets [purchased] have to be complimentary. It's going to be an asset that enhances shareholder value," said Ray Ballotta, an advisory partner at Deloitte specializing in M&A. "A lot of rigor and thought has to be put behind transformative deals. Public equity are not going to look favorably upon anything that strains their financial position."

In its breakdown of 2017 M&A activity and projections for 2018, consulting firm EY said 2017's total of $343 billion of global oil and gas deals was the lowest in the last half-decade. The firm said shareholder pressure is one of the reasons M&A activity is expected to go up in 2018.

"Risk sensitivity and a continued focus on internal performance improvement may have delayed the uptick in deal volume we expected in 2017. But the need to demonstrate appropriate returns is now pushing companies to reposition their portfolios and seek economies of scale, which in turn we anticipate will underpin more M&A activity in 2018," said Andy Brogan, EY's global oil and gas transactions leader.

One of the reasons for the drop in M&A volume in 2017 was a near complete halt in activity in the West Texas Permian Basin, where Deloitte said dealmaking in the second half dropped to 10% of the level attained in the first half of 2017 and the last half of 2016.

A lack of available acreage and the desire to improve drilling results helped knock M&A activity down substantially. "The land grab did come to a halt in 2017," Ballotta said. "The focus in the Permian is now more on execution."

While Deloitte does expect some pickup in Permian activity in 2018, the firm said plays like the Eagle Ford Shale in South Texas and the DJ Basin centered in Colorado are becoming more popular. Two other gas-heavy regions, the Haynesville Shale and Appalachia, are also becoming more popular.

"You have to look at export opportunity … and that could help some of the Haynesville opportunities," Ballotta said. "In Appalachia, there's opportunities for consolidation, and that goes well with the 'lower for longer' mantra [about prices]. Operationally, there's optimization opportunities … which leads to more productive assets."

The impact of private equity could be significant in 2018 in a specific way: mineral transactions, where companies do not buy the acreage but buy the royalty rights to the oil and gas underground.

"If you look at it, there are 350 private equity teams with more than $100 billion in equity out there, and there are still going to be people still looking for ways to invest in this space," Ballotta said. "We're seeing a lot of mineral transactions, whether it's in the Permian or not."