In a year when the UK will come under intense global scrutiny of its climate change policies, merger and acquisition activity in the basin will have energy transition as a new factor to contend with.
This takes in both the operators as well as companies in the oil field services (OFS) sector.
A recent global oil and gas transactions review of 2019 by EY found the M&A scene was decidedly lacklustre, with deal volume and value down 18.4% and 10.8% respectively.
Andy Brogan, EY global oil and gas leader, says: “2019 brought a greater focus on environmental, social, governance and energy transition considerations and these will continue to be key themes for how capital is deployed in 2020.”
But the North Sea faced some unique factors, not least the $15 billion worth of oil and gas assets that changed hands in 2019. Wood Mackenzie principal analyst Neivan Boroujerdi expects more of the same as oil and gas majors look to continue the trend for selling off assets and newer owners seek to churn investments which means that there should be bargains to be had.
The North Sea’s struggling OFS sector has faced a double whammy of still-difficult trading conditions and a decline in investor appetite. Nevertheless, EY’s ninth annual review of the UK OFS industry found that while low margins should have reduced the number of companies in the sector, instead they have increased. According to Celine Delacroix, EY’s global oilfield services leader, this means the sector is ripe for consolidation.
“I am now spending a greater amount of time on M&A than I was on restructuring,” she said. “The key driver of this activity is divestment of non-core assets.
“There is pressure on everybody, the operators and contractors, to increase their return on capital employed, their share performance and shareholder returns.
“This pressure translates into them reviewing the portfolio and identifying which businesses they want to sell, keep or optimise. In 2019 this trend of divesting non-core assets started and it is accelerating.
“Market conditions are still very tough. There is still some pressure on contractors in the supply chain.
“Therefore the way to increase these margins is getting your house in order and divesting these assets which have lower returns and margins.”
So who is buying these less than optimal assets? Ms Delacroix sees trade buyers in other industries widening their scope into the energy sector, as well as the return of that rare beast – specialist venture capital buy-and-builders. However these are not paying over the odds.
She said: “We have seen other companies in other segments looking to optimise non-core assets or integrate and broaden their service offering.
“We have seen private equity – especially the more specialist funds – coming back buying assets maybe more cheaply than they would have done before.
“In general, everybody was more cautious so deal activity is not that strong. But it is interesting that now these specialist private equity companies are reinvesting because they are able to spot good deals in market.”
The sector has remained subdued and Ms Delacroix believes valuations are now “decoupled” from oil price. Listed companies in the sector bear the brunt of significant downward momentum. Part of this is due to pressure to see evidence that these firms are getting with the programme of energy transition.
She said: “If you look at where oil prices are and how prices have performed, the sector is still on a downward trend – and that trend is continuing.
“We see a decoupling of oil prices and the OFS sector because investors do not believe in the growth of the sector. Also there are a lot of environmental pressures to invest in more diversified oil and gas companies. Asset managers have sent letters to various companies to tell them ‘we will look at our portfolio in light of your diversification towards non-fossil fuels’.”
Derek Leith, EY global oil and gas tax leader, argued that companies in the sector needed to improve the story they were telling to demonstrate their willingness – if not ability – to embrace low carbon.
He said: “Now it has never been more vital that it puts together a compelling narrative, certainly for OFS sector, about how they can use urgency around decarbonisation of production facilities in the upstream sector, how they can see that as opportunity to add value and expand their services. Then the movement towards clean energy: how they can harness the skillset they have in their organisations and the technologies to pivot over time towards that.”
He acknowledges there is palpable frustration in the supply chain as significant contracts on UK offshore wind projects, for example, go to large international companies. As a result, companies are currently sceptical about the opportunities.
He said: “The big problem is there’s an awful lot of emotion in the climate change debate and a lot of froth in coverage in terms of how quickly things can happen.
“If you look from an international perspective there is very real opportunity.
“If you look at on and offshore wind most of that has been overseas companies bringing capital and expertise to the UK. There has been some UK aspect to it, but it has not been that significant. From a UK perspective, how do we become more of a player in this area? That is the challenge for OFS.”
Another issue for companies looking to join in the transition to low carbon is profitability.
Ms Delacroix said: “There is a question mark around returns from contractor perspective – what returns are you making on these deals? Especially depending on what you do with the wind farm, it can be difficult to make good money.
“The business models around new activities around renewables have not yet been optimised so contractors can make money.”
However innovative companies such as those emerging from the Oil and Gas Technology Centre (OGTC) have an edge on larger more established companies when it comes to buyer appeal.
She said: “If you look at M&A activity around energy transition, a lot of it has been building expertise by buying people and specific expertise rather than buying companies.
“Some have bought start-ups to position themselves in different industries buying new technologies – such as in biofuels and green chemistry.
“Aberdeen has a lot of innovation and new technology – it can be promising for the industry there to grow this side of the market.
“There is clearly demand from a broad range of companies.”
WoodMac’s Mr Boroujerdi also sees low carbon as a major focus for investors. “The North Sea will be at the forefront of decarbonisation this year,” he said.
“Harnessing renewables to address the carbon intensity of supply leads the way.”
He pointed to Norway’s ambitions to expand electrification outside of Equinor’s existing Utsira High power-from-shore project and its Hywind Tampen floating offshore wind development.
Norway leads the way in terms of decarbonising offshore assets, but WoodMac expects operators will move ahead with feasibility studies for the electrification of platforms across the Central North Sea and West of Shetland. However it’s not an easy task.
“Adoption at scale is key,” Mr Boroujerdi said. “While standalone economics from hydroelectric power-from- shore look good in Norway, repeatability in the UK and elsewhere isn’t possible. The economics of other projects will need to improve.
Operating costs and carbon price savings, coupled with shareholder pressure, will need to offset the additional capital investment required.”