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Industry should adapt to new level of volatility

Industry news
Industry news

Professional services firm PwC said the oil and gas industry will need to adapt to the new level of volatility within the sector.

The company’s oil and gas team said there was little expectation of a rapid rebound in oil prices, which have dropped by 46% in the past six months.

From more than $100 a barrel, the price of Brent Crude has dropped to around $60.

Drew Stevenson, PwC’s UK energy deals leader, said:“Oil prices remaining at the current level for a sustained period will light the touch-paper for mergers and acquisitions (M&A) in 2015.

“As the UK industry positions itself for a more uncertain future, we expect to see deal activity levels pick up throughout the year ahead.”

PwC have made five predictions for the years ahead in the wake of the industry’s current climate.

Reactive public company equity valuations

Communicating value in the complex world of oil & gas has always been a challenge.

The interaction between today’s traded oil price and the key drivers of shareholder value in what is a long term industry, such as forward price curves, production profiles, economic viability of reserves, production sharing, production costs and hedging makes this a complex equation.

UK equities in the sector as a whole are down 18% since the start of the oil price decline, with much higher drops for companies in the Equipment & Services (30%) and Exploration & Production (42%) segments.

There is little meaningful consensus on when and how far the oil price will come back up. Analysts’ long term views are being moderated down almost on a weekly basis, illustrating how little real visibility there is.

As a result, we anticipate more distress sales and opportunistic public bids for companies with good underlying assets but the wrong financing structure. We may even see the first hostile takeover in the Oil & Gas sector in living memory.

Cash constraints

We expect the oil and gas industry in its current form to be increasingly cash-constrained throughout FY15.

New debt will come at a cost, and existing debt will come under increased scrutiny and increased risk of covenant breach.

Reserve-Based Lending (RBL) in particular will be more expensive and less accessible, as banks adjust their base oil price assumptions down for lending.

We expect banks to provide some support to the industry as this is a global – not just UK – problem. Nevertheless, even good companies may see some distress if they are in the wrong place in the capital expenditure cycle.

New sources of capital

Sovereign Wealth Funds, State-Owned Enterprises and specialist energy funds are all sources of the capital that the industry will badly need.

We see inbound investments stepping up through the year as cash-rich institutional and private investors look for bargains.

Some of these have the luxury of a longer term outlook than the markets afford our public companies, so will be able to take a different view of the long term oil price. Expect cash-absorbing businesses to be snapped up by opportunistic bidders.

Write-offs

As we move into the Q1 (quarter one) reporting season, companies will need to reassess their commercial reserves and there will be more impairments across the industry.

Different companies will adopt different approaches, but the reduction in capex is already hitting oilfield services and asset-heavy businesses hard.

As a result, we may see some businesses take this opportunity to clear out ‘bad news’, such as writing down exploration expenditure on marginal assets and accelerating decommissioning but watch out for the impact of reduced gross assets on reported gearing and net asset covenants.

Big M&A for cost reduction

As we head into Q2 (quarter 2), we’re likely to see more large M&As occurring, a trend that could accelerate as the year goes on.

These will include an increasing proportion of paper-based transactions in the E&P sector and the supply chain.

Cost reduction has been the mood for some time now, well before the price started to tumble, but M&A is a clear way of achieving substantial cost reductions.

We may even see some activity among the International Oil Companies; it’s been 16 years since BP’s merger with Amoco triggered a wave of consolidation – could the 2014 oil price plunge be the trigger for a new round of mega-mergers?

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