Three quarters into 2013, A&D activity seemed to have smoldered, but never quite caught fire. While analysts and industry observers predict that 2014 will see deal-makers put transactions and value back on course, the extent of recovery is up for debate. New shale plays are opening up to investment, but the market may head in new directions.

Deal activity in 2013 has been stable, but value has not. Measuring the extent of the slowdown is difficult, because firms measure it differently.

Overall, the third quarter was slow. For oil and gas deals valued at more than $50 million, there were 43 transactions valued at $16.4 billion. In 2012, the market saw 45 deals worth $37.6 billion in the third quarter, according to a PwC report released in late October.

In the first half of 2013, deals and their value fell by 29% compared to the first six months of 2012.

“I expect a rebound,” says Christopher J. Simon, managing director and co-head of acquisitions and divestitures for Raymond James & Associates. “Generally, the A&D market bounces back pretty quickly when it gets a little soft.

“Although the total transaction values are down, there have been more deals so far this year when compared to last year. We just haven't had the few large deals that tend to push the total value up.”

Gabriele Sorbara, a New York-based analyst at Topeka Capital Markets Inc., says everything is for sale at the right price. Deals will be made in 2014, but all won't be rosy for mergers and acquisitions activity.

“At current valuations, you are going to have a soft market in 2014,” Sorbara says. “You are going to see, maybe in terms of deals, the count higher, but with smaller packages on the market—and a lot of it noncore assets.”

Foreign investment, gas assets, joint ventures and midstream infrastructure for E&P companies are all in flux. Few see large corporate mergers on the horizon, because valuations are at historic highs. Others believe foreign investment in the U.S. is saturated.

The prevailing wisdom is that E&Ps looking to acquire, drill and flip acreage are passé. But some companies are so committed to that strategy that they may not diverge from it soon.

While specific assets in top-notch plays are being snatched up, corporate buyouts are less likely. “In our view, many E&Ps have achieved high 'growth valuations' that reflect strong oil pricing, positive global macro, and M&A sentiment,” John P. Herrlin Jr., head of Societe Generale's oil and gas equity research, said in a recent report. “Today's E&P stock laggards tend to have more conservative upstream growth rates, focus on ROCE [return on capital expenditures] versus shorter-term volume growth, and are more diversified. At this stage, we prefer size-based diversity.”

The high ground

In the fourth quarter, E&P deals got rolling.

In October, Forest Oil sold its Texas Panhandle assets for $1 billion to a private-equity-backed firm, Templar Energy LLC, in order to focus on the Permian. Bill Barrett Corp. let go of its West Tavaputs natural gas property in the Uinta Basin, Utah, for $371 million. And Cabot Oil & Gas Corp. sold its Marmaton and West Texas assets for $188 million to keep its focus on the Marcellus. A number of observers were disappointed with the sales price for Cabot's Marmaton asset. “But at the end of the day, what they're doing is taking proceeds and putting them in the Marcellus, where they're getting north of a 100% internal rate of return,” Sorbara says.

In Simon's view, these companies and others are rightsizing their balance sheets and selling assets that aren't necessarily core but are still attractive. The strategy is simple: Sell noncore assets and put capital into core properties.

In 2014, the biggest factor in the market may be private-equity-backed companies that have recognized they need to further develop their properties in order to realize proved-reserve pricing if they decide to sell. The days of drilling a couple of wells and selling acreage are gone, for the most part. More sellers will have properties with significant proved developed producing (PDP) value. “That's what the market really wants,” says Simon. “That market is willing to be aggressive if the properties have been de-risked and there's a component of cash flow and significant proved reserves as part of the value allocation.”

Companies will manage their available capital and funnel it to assets with the best returns. “If that means selling properties to raise capital, I think we will see it,” Simon says. “Many of these companies are drilling their properties.” One E&P recently told him it has built a legitimate oil company with the rigs and operating staff needed to produce for the long term.

Many analysts think the hold period for sales in the future will be as many as five to seven years. For some, it's “not going to take a year to get their properties ready for market. I think by next year, certain companies are going to be ready to go to market,” according to Simon.

Master limited partnerships (MLPs) also continue to be active in the market, and every year they increase their percentage of acquisitions. Going forward, they will need to continue to acquire properties—and in an increasingly competitive market.

“They're going to have to look for creative ways to acquire,” Simon says. “Some are considering teaming up with drilling partners to jointly buy properties that are only partially developed. The MLP can take the lion's share of the producing assets and the drilling partner can take the majority of the drilling opportunities.”

Targeted, but acquirer?

For some time, Pioneer Natural Resources Co. has been rumored to be an acquisition target.

But the $29-billion company could fetch a purchase price of $40 billion or more.

“I just think it's very unlikely at these levels to see corporate M&A,” Sorbara says. “More likely, a lot of these private companies that may have been takeout candidates in the past may go public.”

Sorbara says 2013 has been a quiet year for corporate M&A, but assets have moved well.

In 2014, those themes will continue. Money is available, but on the sidelines. Private equity is flush with cash and waiting for the right opportunity. But few buyers will come into an M&A market that requires a 20% to 30% premium on enterprise value to make a takeover happen, he says.

Companies such as Energen Resources are the exception, and would make sense for a private-equity firm. Energen's utility business could be spun off and its valuable San Juan Basin asset “could be a multibillion-dollar asset,” Sorbara says.

“There are select companies that could be takeout candidates. But a company like Energen probably hasn't reached its full value yet, and would really require a 20% to 30% premium.”

The question is how much private equity is willing to pay with the premium.

For private companies, though, raising capital has to happen to develop acreage. “The public market is the easiest,” Sorbara says.

Several companies, such as Diamondback Energy, have accessed the public markets and increased their value significantly.

In Ohio's Utica shale, Aubrey McClendon announced he has $1.7 billion to spend and a joint-venture partner. “He's been leasing like a maniac in the Utica, paying as much as $20,000 an acre,” Sorbara says. Despite his healthy coffers, McClendon could take his company public at some point; the former Chesapeake Energy chief executive officer is no stranger to the opening bell.

Gas appetite

At The Oil & Gas Asset Clearinghouse, Ron Barnes, executive vice president and chief operating officer, says 2014 should be a step up as more transactions are done. The Clearinghouse handles transactions ranging in value from $1,000 up to $1 billion.

“We expect to see a lot of people cleaning up assets next year,” he says. “There are still people trying to figure out how to increase available capital to drill higher-rate-of-return wells.”

Natural gas assets will be no exception.

“Oily assets may be in favor, but even in the times of lowest prices there has always been a big appetite for buyers to acquire gassy assets,” Barnes says. “If you think about it, buyers want to acquire properties at the bottom of the market no matter what they are buying. If gas prices are down, and there is some expectation that they can increase by 5% …or by 50%, then you want to be a gas buyer.”

In the months ahead, private-equity buyers will likely look to acquire such undervalued assets, particularly out-of-favor gas and conventional assets, Sorbara says.“That's really a function of current market valuations. A lot of guys aren't willing to sell them, but unfortunately, they do need to sell them, in order to improve their balance sheet and redeploy capital.”

Clark Sackschewsky, a partner in BDO's Houston office, says natural gas holds interest because liquefied natural gas (LNG) will soon be exported to some degree.

“There's going to be more infrastructure in place to get it to the LNG facilities and to other markets out there,” he says. “Production is going to go up on the natural gas side once additional markets open up and the infrastructure is there.” The infrastructure hasn't caught up with production yet, but “it's getting there.”

JV decline

Of the 10 largest deals made during the first half of 2013, at least 60% involved international buyers, according to Deloitte. So what does the future hold for overseas money flowing into the largest A&D market in the world?

Simon notes that resource plays or shale-play joint ventures were a big market for international investment in the past several years. “That has slowed down a bit,” he says. “There are fewer JVs being announced. There is still some demand, but I think the big joint ventures are in place.”

Foreign investment is also attracted to conventional plays, however. “The U.S. is an attractive place to invest for these companies and they are going to continue to do so,” he says.

An international company, for instance, told him recently it wants to transition to operating its joint-venture property.

“They want sizeable acquisitions. They want management teams that can help them execute on it and operate,” he said. “There's still demand out there, but they're going to be very selective.”

Sackschewsky also sees international investment growing in popularity and joint ventures diminishing. Joint ventures have been a vehicle for US companies to unload the costs of a portion of their operation more rapidly than a full merger or acquisition. They also provide upfront cash flow and an easy entrée for the international investor into the US market.

International dollars are also flowing into US private-equity funds and may become a vehicle of choice for international investors, Sackschewsky says.

That was the case in an otherwise low-key third-quarter 2013. Foreign buyers and private-equity players returned to the deal table as buyers of energy assets and drove the bulk of M&A activity in the sector, according to PwC US.

“In the past 18 months, what you're seeing is that rather than buying companies, they're actually just entering joint ventures and providing capital to do the drilling,” he says. Foreign investors have come to realize that instead of buying a whole company with its associated liabilities and other risks, they “can just invest in the prospect directly.”

In the pipeline

Midstream transactions were dormant in second-quarter 2013, but in October, several large pipeline deals were struck. Regency Energy Partners LP bought PVR Partners LP for $5.6 billion. Crestwood Midstream Partners announced an $8-billion merger of its various entities with Inergy LP, and the purchase of Arrow Midstream Holdings for $750 million. Azure Midstream Energy LP agreed to joint ventures with TGGT for $910 million.

Midstream infrastructure is ripe for investment, according to some analysts. For many international investors, that infrastructure may be crucial to bringing US supplies to their home markets to satisfy exploding demand.

Ed Hirs, a managing director of Hillhouse Resources and professor of undergraduate and graduate energy economics at the University of Houston, says a great deal of build-out is needed in the midstream. He expects activity in the sector to remain brisk.

“We need to build the infrastructure,” he says. “Obviously, there's a question of whether to do rail or pipe. Then, as some of the smaller players finish their construction and develop cash flow, they will become acquisition targets.”

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