Across the world, economic downturns are often followed by big deals and transformative market moves. The 2008-09 downturn, for instance, was followed by a spate of deals such as Pfizer-Wyeth, Lufthansa-Austrian, and Kraft-Cadbury, albeit with a lag of two to four quarters. The energy sector, too, is no different.

The last time the world experienced simultaneous oil demand and supply shocks, in 1997-1998, the result was a set of mega-mergers that created the ‘supermajors’ of today, with deals such as Exxon-Mobil, BP-Amoco, and Total-Fina-Elf. During that period deals exceeded $150 billion a year, dwarfing the average of below $30 billion in the years preceding.

More recently, too, there is a clear trend towards major restructuring following periods of oversupply — examples include the Exxon-XTO deal in 2009 and Shell-BG in 2015.

But as oil prices recovered over 2017-19, deal flow became muted, with most deals restricted to the American shale basin consolidation, targeted at scale and earnings growth.

The year 2019 witnessed a sharp drop in deal flow in O&G (oil and gas), if one leaves out the Oxy-Anadarko outlier, and we entered 2020 with a quarterly deal count that was lowest in last two decades.

Next phase of consolidation

The current market conditions, with an overall economic downturn and an amplified oversupply, have therefore all the bearings of ushering in the next phase of consolidation.

There are tell-tale signs that both asset, as well as corporate, deals that may follow. On the asset side, there is a strong push towards doubling down on the core value-accretive portfolio, and most IOCs have set up divestiture programmes to meet debt-reduction targets. Such programmes are not just good to have, but in the current scenario are lifelines to manage the deep liquidity crunch. As a result, there are O&G assets worth over $300 billion that are currently in the market seeking a buyer.

On the corporate side, the E&P (exploration and production) sector is in deep distress, with the current market situation further aggravating an already depressed market.

We are, therefore, seeing high debt levels, lack of access to financing capital, and rapidly deteriorating cash positions, pushing companies to seek buyers at distressed prices.

The impediments

There are, however a few strong impediments that we need to factor in, before we can see a surge in M&A activity.

First, there is today a unique dichotomy playing out in the M&A markets. While asset valuations are at their lowest since 2009, with EV/EBITDA hovering at 5-6 against the historic average of eight, the acquisition premiums for the assets are touching historic highs. There is a strong need for such a disparity to settle, with a lowering of acquisition premiums, for any reasonable deal flow to proceed.

Second, the widespread corporate distress, while opening up opportunities for buyouts, also brings about some adverse effects. It not only limits the universe of potential buyers but also raises questions on the quality of assets that are currently floating in the market.

Many of the potentially vulnerable targets have high debt and low operating costs — but lack sufficient scale to be attractive targets for serious buyers.

The ideal targets for majors — ones which are viable at low prices but with depressed valuations — are selective and few. Corporate acquisition, therefore, is likely to be intermittent and focussed on quality of assets, and not necessarily the distressed producers.

In effect, we anticipate M&A deals to be cautious in the current environment, but a few transformative deals are likely to happen in the next 12 months. That brings into focus the implications for the Indian O&G sector. India uniquely qualifies as both a major O&G consuming market in the long term with over 100 MMTPA (Mn Tonne per annum) of refinery capacity addition expected in the next 10 years, and also a major oil importer for the foreseeable future, with expected 4-6 million barrels of imports annually over the next five years.

We are, thus, both potential targets for global majors and internationalising NOCs (national oil companies) seeking growth, particularly in R&M (refining and marketing), but also in need of achieving supply security for our refineries.

As a buyer, the next 12 months offer a unique window for India Inc to acquire assets to both diversify, find replacement reserves, but also for us as a country to strengthen our resource security. All amidst a context of reduced competition for resources, given the majors’ financial woes, and an abundance of potential opportunities at reduced prices.

Plan ahead

To achieve this, however, we need to keep a few important guardrails in minds.

First, there is a need to get aligned with a $40/barrel world when assessing targets. This new wisdom would be key to identify resilient, long-term bets.

Second, actively stress test for various scenarios, like a prolonged $30 world, before making a large bet.

Being one of the few countries with the intent and pockets to invest, we should think outside of the box to identify what would work best for us in the long term — this could mean not only looking at asset or corporate deals, but also carve-outs to invest in specific niche capabilities, markets, JVs (joint ventures) to bring in strong long term partners, or other such innovations.

While the actual flow of deals may take two-to-three quarters, it is important to prepare and have a clearly thought through strategy to double down on choice targets once the time is right.

Mukherjee, is Managing Director and Partner, and Fitz is Senior Director, Center for Energy Impact, at Boston Consulting Group

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