Oil & Gas M&A: A sea of opportunities or a pit of value destruction?


Mergers and acquisitions activity is unavoidably correlated with the oil price movements. In simple terms, when the oil price is high companies are looking to structure deals that will allow them to grow, boost their balance sheets and possibly expand into new regions and resource types. When the oil price is low there is no confidence that acquisitions will create any value and investors are more skeptical to fund these types of moves.

And it is easy to understand investors and shareholders concerns when it comes to funding and approving large scale acquisitions. In an industry so susceptible to commodity price swings, value can be more easily eroded through M&A rather than created. This is because the implied long term oil price that is usually used when valuing an oil & gas assets can easily drop or rise after the deal is closed and hence destroy value for either the buyer or the seller.

A prime example was the acquisition of XTO Energy by ExxonMobil one of the largest deals ever in the US L48 space. Exxon agreed to acquire the shale specialist XTO under an implied price of 6-7 $/mmbtu for natural gas with the assumption that domestic US gas prices were bound to rise in the next years. However, the shale revolution has created an abundance of natural gas in the States plunging the domestic gas prices to the levels of 2-3$/mmbtu. A gas price in these levels would definitely lower the price of the deal to reflect the fair value for Exxon but that scenario was hard to predict back in 2009 when domestic gas demand was soaring in the US.

This prologue with the Exxon example leads to the main subject of this article: How can companies create value through M&A, especially in this price environment?

The answer is definitely not simple and straight forward. This is because the main reasons that make a deal successful or not are simply beyond the oil price. The success factors unique to each company are :

  1. The value of an acquisition is different for each company. The cost of capital is a key factor for mergers and acquisitions with differences in the cost of capital between a buyer and a seller implying differences in the deal valuation, creating opportunities for both. An oil major for example can borrow with better terms and lower risk interest premiums compared to a junior company with no track record in the industry

  2. Success or failure of a deal is not measurable only by valuations. An acquisition or a merger has the potential to transform the company and not only change its balance sheet. Capabilities acquisition, operating model adoption, synergies and scale-driver acquisitions might not contribute directly in a company’s balance sheet but will provide the fundamental basis for continuous success of a company

  3. Post merger integration is key. Either fully integrating the companies into one entity (eg. Shell-BG) or keeping the entity separate (Exxon-XTO) the companies need to ensure an effective PMI that ensures elimination of overhead costs, aggressive pursue of synergies and an efficient organizational structure

To conclude we want to emphasize that the oil price shouldn’t be the only driver when setting up the M&A strategy. Companies that have clear set targets, holistic acquisition frameworks and robustness in post merger integration are ready to grab the opportunity in this troubled market.

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