ERNST & Young’s Global Capital Confidence Barometer is a regular survey of senior executives from large companies around the world conducted by the Economist Intelligence Unit (EIU).
Our panel, the “Ernst & Young 1,000”, comprises selected clients and contacts and regular EIU contributors. This panel of 1,000 C-suite executives has a subset of almost 100 oil and gas executives.
This subset allows us to identify boardroom trends and practices in the way companies manage their capital agendas.
Ernst & Young’s fifth Global Capital Confidence Barometer finds that more than a half of our oil and gas respondents are cautiously optimistic with regard to the broader economy, with more than half (52%) remaining focused on growth over the next 12 months and only 4% now focusing on survival.
This year, the sector has been challenged by a series of shocks, particularly the social/political unrest in North Africa and parts of the Middle East and the Japanese disasters.
Oil and gas executives are now facing strong economic headwinds; we are seeing downgraded economic growth forecasts, and markets are being roiled by waves of disappointing economic news, confounded by political paralysis and worried about serious policy mistakes. We are in a period of high policy risk: not just in the US, but in Europe and China, and in Opec too.
From the oil markets perspective, several factors are keeping these on edge. First, there are very real, substantial concerns about the economies of the US and Europe, the possibility of a contagion, and the implications for energy demand. Second, the restoration of Libyan production is getting underway, but there are serious questions as to how much production will come back and how fast and how Opec will respond.
When asked about the main regulatory risks that could derail the growth agenda, environmental risks were seen to be the biggest threat to our oil and gas respondents, ranking ahead of banking/financial reform and taxes, which the broader global sample of respondents had seen as greater threats.
In an unprecedented departure from the historical norm, the outlook for deal volumes is stable against a backdrop of significant short-term volatility. In fact, dealmakers’ appetite has increased marginally in the last six months, with almost half (48%) of oil and gas respondents expecting to make acquisitions in the next year, compared with 42% in April 2011.
Many companies have learned to adapt and operate in a new and uncertain world. They are well positioned to seize opportunities and plan to do so, as many have reduced their financial risk and have the ability to take on more business risk. Notably, the acquisition expectations of the oil and gas sample of respondents are consistently higher than those of the broader global sample.
As might be expected given the broader turmoil, deal pressures generally increased sharply over the last six months, with the oil and gas respondents notably flagging the sharply-increased external regulatory pressures along with the internal pressures around board and/or audit committee scrutiny.
Transaction activity can create value, both from expected as well as unexpected variables and factors.
Looking at such activity for the past year, our respondents noted that value creation did not always come from where they had expected it would. Notably, procurement leverage, geographic reach and brand equity delivered more value than was anticipated, while conversely, innovation and the selling of new or existing products and services through new or existing channels delivered slightly less value than anticipated.
Asked to identify the issues most likely to contribute to missed expectations for deals over the last year, the respondents saw thorough market due diligence and poor execution of integration as the most significant issues contributing to missed expectations.
The willingness of companies to divest assets is also an important element in the deal market. More than a third (37%) of the respondents expect to execute some type of divestiture over the next year, up slightly from their expectation in April 2011.
Notably, they are generally more likely to use divestitures than is the broader global sample.
Capital market outlook
With relatively high cash balances and a growing aversion to leverage, 70% of the oil and gas respondents plan to use cash or non-cash equity as their primary funding source for deals.
The trend toward debt reduction continues, with 62% of the respondents reporting debt-to-capital ratios of less than 25% and another 33% with ratios between 25%-50%. Even those companies planning to use debt in their acquisitions are typically planning to use less than in previous years.
In conclusion, we are seeing a new paradigm, with relatively strong M&A activity and market volatility now able to co-exist.
Critically, leading companies are shrugging off the continued market upheaval and focusing on growth and M&A.
For them, this is not 2008 all over again. They have spent the past three years reducing the financial risk on their balance sheet and taking tough efficiency measures needed to strengthen their positions, which helps them manage in volatile times.
Ally Rule is an associate partner – transaction advisory services at Ernst & Young