At the end of the movie “The Cincinnati Kid,” Steve McQueen slumps into an alleyway, having just seen his stellar poker hand crushed by a rival poker player’s straight flush. A shoeshine boy comes into view, cajoling him to pitch pennies.

After a moment the already wiped-out gambler throws a coin and loses again. Sometimes, that’s the way it goes.

The consensus is that in 2016, the induced panic of unsettled commodity prices has given way to a new industry reality—for E&Ps, these really are the cards they’ve been dealt. That could get things moving on the A&D front as optimism fades into cold, hard calculation.

What makes this year different is that, barring a significant rebound in commodity prices, capital markets are tightening, less than one-fifth of production is hedged and demand is outmatched by supply. In the months to come, far less rope is left to hang onto and more transactions, made in desperation by capital-starved E&Ps, will follow.

Melinda Yee, partner with Deloitte & Touche LLP and leader of Deloitte’s Oil & Gas Merger & Acquisition Transaction Services practice, said uncertainty remains, particularly in how lenders will react. Tougher decisions—“making more bold moves for the long term”—may be in order, she said.

“The difference going into 2016 vs. 2015 is the view on where oil prices are going and this lower-for-longer period,” she said. “We’re not going to see oil reach $100 again, certainly not by the end of the year.”

Companies are more inwardly focused and trying to drive efficiencies, particularly in the upstream.

Yee noted that transactions haven’t been shut down. They’re simply more targeted. “The transactions that are occurring are smaller, more niche-type plays as people are being very selective and tactical in where they’re investing,” she said. “They’re investing where they already know the geology.”

After a five-year stretch in which annual transactions averaged roughly $55 billion, A&D collapsed in 2015. Deal values fell to $23 billion, and transactions of at least $100 million dwindled to 57 from 122 deals in 2014.

The A&D market stumbled mainly because a number of deals never left the table, said Craig Lande, managing director with RBC Richardson Barr. From 2010 to 2014, the perceived comfort zone for deal making was $70 to $80/bbl. “Here we were last year, at $40 to $45 oil, and deals were getting done,” Lande said. “Not at the same clip as past years, but I think what it shows is this industry is incredibly resilient.”

The year was a mix of lackluster activity, huge losses in market valuations, abandoned but still viable deals and the new big three plays. The shock of 2015 is giving way to the work ahead in 2016. Buyers and sellers, in particular, have to see the market for what it is and find a middle ground in the bid-ask spread.

Yee said sellers need to consider who has neighboring property or infrastructure and who knows specifics of the geology well enough to be interested in an acquisition.

“Sellers need to think about how they approach these buyers,” she said.

Bluffs

Experts expect this to be a rebound year for A&D. Companies will scrounge for capital through divestitures, and buyers and sellers will begin to see eye to eye on asset values.

While capital markets have welcomed Permian Basin E&Ps, outside of the Midland and Delaware basins, companies may be out of luck.

For some E&Ps, hunting capital will be the priority. Large-cap independents will likely turn to asset sales, joint ventures or partnerships with private equity. E&Ps that can’t find capital via these methods will be forced to restructure out of court or by filing for bankruptcy. Regardless, the upheaval in the oil and gas industry has given way to a delicate stability in market prices—enough to make deals possible for some and vital for others.

In the E&P trenches, companies are keeping their heads down, cutting spending and fretting. Tight capital markets, eroding borrowing bases and hedge roll-offs are providing less cover.

Charles Dewhurst, leader of the Natural Resources practice at corporate consulting firm BDO, said some of his clients are in the “dire need” capital category.

“Their liquidity is poor. They’re facing asset impairments, difficulties with their bank borrowing limits, maybe they are overextended at the banks,” Dewhurst said. “Certainly those who thought they could tap into the capital markets have had a rude awakening. There’s no real liquidity in that department.”

But some of Dewhurst’s clients are at the opposite end of the spectrum, and they see opportunity. They have dry powder and can buy assets “that two years ago were ridiculously overpriced. Now they can buy them for cents on the dollar,” he said.

“Our client base covers that wide range of opinion,” he added. “One end or the other, the bottom line is that 2016 is going to be a really big year for M&A activity. It’s going to be a combination of opportunistic buyers and desperate sellers who don’t have any of the exit strategies that were previously available to them.”

Lande expects many more motivated sellers this year. But they need to accept “the level we’re at,” he said. If sellers can’t live with current valuations, it will be best for them to stay out of the market.

“A lot of sellers were hanging on, hoping for a better day,” he said. He has represented both sides of deals. “Unfortunately, hope is not a great strategy.”

Unsuccessful deals will be revived in 2016. “There’s probably $15 billion in failed deals last year,” he added.

Buyers, too, need to temper their expectations of fire sales and “steals,” because with the exception of small deals here and there, that strategy won’t work.

“With larger deals, the market is very efficient. I don’t care if we’re at $30 oil or $130 oil, core-of-core stuff is going to trade at a premium,” Lande said.

Deals will get done by various means, but the parties will need to be creative to address the disparity between sellers’ asset costs and what those assets will now fetch on the market. “We’ve got to find a way to narrow the bid/ask spread.”

One incentive is “price kickers” that give sellers the ability to realize additional proceeds on a sale based on various terms, such as six-, 12- or 18-month look-backs at commodity prices.

Private equity is a wild card, Dewhurst said. “They are very interested in the energy sector, but private equity is going to be cautious about the players they associate with. We’ve seen that already. They will go all in with the good deals, but shy away from some of the questionable deals.”

The ante

With a supply of assets on the market, the mindset of potential acquirers will be a mix of enthusiasm, patience and wariness. Larger public companies and private equity will be the most active players. While large-cap companies are well-positioned, with relatively strong balance sheets, “they tend to be very patient,” Lande said.

And, with many assets already in place, some have “too much to say grace over,” and thus are incredibly selective for core-of-core assets.

The large-caps’ mindset is to wait until things get worse. However, they have the financial wherewithal to pull the trigger on assets that interest them.

Small-cap public companies and MLPs, however, are unlikely to be active, with their access to capital markets limited and their balance sheets levered.

“Small caps and MLPs are essentially fighting to survive,” Lande said.

That leaves private equity firms to pick up the slack. The huge amount of cash they have been stockpiling—more than $85 billion—is ready to find a home.

“They see this as an opportunity to put capital to work in what they hope is the low point of the cycle,” he said.

Since 2010, private equity has increasingly made up E&P onshore A&D demand, and RBC estimates it could command half of the A&D market in 2016. Lande estimates that 250 U.S.-focused E&P management teams are looking for assets. “I’d say half have no assets right now,” he said.

Large- and small-cap E&Ps and MLPs have seen their worth dissolve at super speed.

Private equity displayed an appetite for legacy gas assets in 2015.

Cash in

Last year, many analysts and other experts expected a rash of deal making. Instead, equity capital markets threw weaker companies a lifeline. In the first quarter of 2015, E&Ps raised $8.1 billion, followed by $3.5 billion in the second quarter.

Only by the third and fourth quarters did equity begin to wane. Now, practically the only companies successfully raising capital are at work in the Permian Basin. Parsley Energy Inc., for instance, raised money in both the third and fourth quarters of 2015.

Large- and small-cap E&Ps and MLPs have seen their worth dissolve at super speed. Lande said RBC calculated the “value destruction” across all E&P sectors in the past 18 months. All told, companies lost a staggering $1 trillion in value as oil prices degraded. MLPs in particular were crushed, losing 94% of their market value.

For the rest of the U.S. E&P universe, times are about to get even tougher.

Only about 18% of U.S. production is hedged in 2016. Despite having higher amounts of hedges in place, small caps and MLPs are worse off because of their high leverage levels. Companies that lack hedges and don’t have cash flow to service debt are going to have to sell some assets.

Draw three

A&D opportunities for public companies were dormant last year with the exception of two regions: the Midland and Delaware basins in the Permian, and the Scoop/Stack area of Oklahoma.

“The Midland Basin had a great year in 2014. In 2015, the Delaware Basin and Scoop /Stack really emerged,” Lande said.

Noble Energy Inc.’s purchase of Rosetta Resources Inc. validated the Delaware Basin and “started a lot of traction there,” Lande said.

WPX Energy Inc. followed with its $2.8 billion acquisition of RKI Exploration & Production LLC, a transformational Delaware Basin deal.

In the Delaware and in Oklahoma, deals should continue. In January, private company Luxe Energy LLC agreed to buy 18,000 net acres in the Delaware. Concho Resources Inc. said it would purchase 12,000 net Delaware acres for $360 million.

Similarly, the Scoop and Stack have seen more deals, particularly with Devon Energy Corp.’s $1.9 billion proposed acquisition of Felix Energy LLC—the first material Stack deal in the market, according to Lande. This January, Lucas Energy Inc. said it would spend nearly $81 million to acquire Hunton Formation acreage. In 2015, the Oklahoma area generated about $4 billion in deals.

Along with the Midland Basin, “those are really the three areas from a resource perspective that at least public companies are going to be looking toward if we stay in a scenario of $30 to $40 oil,” Lande said.

In addition to the Devon/ Felix transaction, several other deals announced in 2015 should have wider ramifications. In October, Encana Corp. agreed to sell its Denver-Julesburg Basin assets in Colorado to the Canada Pension Plan Investment Board for about $900 million. Lande said the deal caught his attention because institutions and endowments have typically relied on other companies to do the buying and selling of assets for them.

“They’re trying to do it in the world on their own,” he said. “It will be interesting to see how many of them follow.”

RBC’s own Blue Whale/Tall City and Element Petroleum Operating II LLC Midland Basin transactions presented a new model for foreign investment. Most Asian JVs from 2010-2013 were busts due to investment in lower quality acreage. This time, a Chinese company directly hired a U.S. management team to put a $1 billion deal together and operate in a core position.

“It will be interesting to see if other internationals will look at that type of model,” Lande said.

Ace in the hole

Elsewhere, 2016 may be the year of alternative strategies.

Yee said that as capital becomes more difficult to find through traditional sources, companies will find other options, such as joint ventures or farm-ins. “It’s not M&A activity, but there are still nontraditional sources that people are finding to raise capital,” she said.

That’s not the case, so far, in the Midland Basin. Despite declines in oil prices, core acreage valuations in 2015 stayed as strong as a year previous, Lande said.

Furthermore, the Delaware’s increased activity and valuations have begun to approach Midland Basin levels.

“At the end of the day, we went down to a $45 oil environment and still saw valuations at levels similar to a $90 oil environment,” Lande said. “The core of the core is resilient.”

Dewhurst said that the Permian has everything going for it. The area has a long history of successful drilling and support from communities familiar with the industry’s ups and downs.

“The great thing about the Permian is the tremendous, broad-spread and easily accessible reserves,” he said. “When you add on to that the potential for shale reserves as an extra level underneath the easily conventional resources, it becomes very attractive.”

The other dominant trend of 2015 was the appetite for legacy gas assets.

Companies such as Encana, Marathon Oil Corp. and ConocoPhillips Co. exited conventional gas assets that had most likely been excluded from heavy capex spending for years. The buyers that emerged were private equity firms.

While management teams probably didn’t set out to pitch conventional gas purchases to their sponsors, many ended up doing just that, Lande said.

“The neglect factor draws a lot of interest,” he said, adding that private equity firms can cut costs significantly from day one while exploring largely HBP assets for upside.

In 2015, deal activity of all kinds fell flat, despite predictions that A&D would see spikes by the second half, then the fourth quarter and then the end of the year. This year, signs continue to point toward an uptick, and acquisitions will again be a game as tricky as pitching pennies and as exhilarating as Texas Hold ’em—deuces wild.

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