M&A on Mute: Upstream Deal Activity at 15-Year Low

Uncertainty from geopolitical headwinds and wild swings in commodity prices are likely to give the M&A market a hard time picking up speed after an uneven year of transactions hamstrung by E&P’s parsimony.

Top of mind for transactions is the Russian Federation’s brutal invasion of Ukraine, which has seen sent WTI prices careening—in the space of a week—from $130/bbl on March 8 to $96.44 seven days later.

Deloitte’s view of the war is that a tight oil market is now even tighter. In a new report, Deloitte says that despite record cash flows, a combination of geopolitical uncertainty, trade controls, inflation and shareholder returns will make oil and gas firms “highly cautious in their spending for M&A in 2022.”

“Even beyond the current state of global economics and energy markets, our analysis of 2021 deal making shows fundamental changes to the M&A strategy of O&G companies, which we expect to see play out in 2022,” the March 10 report said.

Discounting the 2020 pandemic year, global upstream M&A deal count remained at a 15-year low—or at about the same level as pre-shale 2005, although an improved macro and oil price sentiment brought back a few opportunistic buyers in 2021. Deloitte points to a decoupling of M&A and rising commodity prices, which the report posits is part of a growing consensus that “long-term demand outlook for hydrocarbons is bearish.”

“O&G capex and M&A decoupled from oil prices in 2021. Despite a 75% rebound in prices, deal activity increased by only 32%, and capex grew by only 17%,” Deloitte said. “Rewarding shareholders through increased payouts and divestment of less-economical or carbon-heavy hydro­carbon reserves drove O&G stakeholder expectations in 2021.”

That fiscal approach has supplanted the companies’ previous imperative to keep their reserve replacement rate at 100%. With stakeholders more interested in production companies reducing their environmental footprint to become lean and efficient hydrocarbon producers, the report said.

“Key deal-making drivers in O&G are changing—cyclical buying or selling will likely make way for strategic, goal-oriented asset exchange,” Deloitte said.

Companies are rewriting the M&A playbook, falling back from previously aggressive tactical and cyclical acquisition in favorite of a more restrained, strategic and environment-focused buying that was evident in 2021.

The first half of 2021 saw the lowest level of O&G deal activity in the past 10 years, but it somewhat rebounded in the second half. Overall, global O&G M&A deal value in 2021 rose by a “modest” 18% to $269 billion, compared to 2020, with recoveries in upstream and oilfield services offsetting weakness in midstream and downstream, Deloitte said.

By sector, the report noted deal values in:

• Upstream rose 70% to $138 billion, led by the majors shedding fossil fuel assets;
• Oilfield service value grew 4.5x to $9.5 billion, driven by an interest in offshore drilling;
• Midstream value fell by 12% to $91 billion, with strong interest from private equity (PE) firms; and
• Downstream activity fell by 27% to $30 billion, led by a shift in value toward upstream.

Deloitte said O&G sector M&A was skewed by thematic changes to deals. The energy transition has altered upstream deal making, with the growing role of lean operators. ESG consideration is emerging as a factor as well, with its effect on buyers’ shareholder returns is evolving.

Joint ventures (JVs) are being prioritized to build a differentiated position in carbon-abatement solutions. Energy information services are enabling the commercialization of new offerings and technologies. And private equity (PE) interest is gradually steering towards building low-carbon infrastructure, Deloitte said.

“While projected record cash flows of O&G companies at current prices bode very well for O&G M&A activity, geopolitical uncertainty resulting from the Russian military invasion in Ukraine and Omicron-induced demand and investment declines—including supply-chain disruptions and inflation—may impede O&G M&A momentum in 2022,” Deloitte said.

But portfolio-rebalancing amid the evolving geopolitical landscape and ongoing opportunities to integrate hydrocarbon and green energy assets could provide some support to the M&A activity in 2022.

Overall, global upstream M&A deal value rose by 70% last year to $137.6 billion after the pandemic wreaked most deal making in 2020.

Deloitte also noted a lack of clear consensus as companies diverged in their acquisition targets. The top upstream deals of 2021 were scattered across the globe and fueled by a variety of motives.

Global miner BHP Group, for example, exited from fossil fuels by selling its $14.4 billion valued O&G business. Aker BP acquired Lundin Energy for $13.8 billion to “unlock synergies in the North Sea while lowering its emissions profile,” the report said.

ConocoPhillips strengthened its position in Delaware Basin by buying Shell assets worth $9.5 billion.

And traditionally gas-focused Cabot’s $9.2 billion acquisition of oil-heavy Cimarex—forming the new company Coterra Energy, focused on commodity, geography and asset diversification for the combined entity.

Private equity also appears to be taking a different approach to investments, as well. Despite stakeholder pressure, firms are investing in LNG, gathering pipelines and offshore infrastructure, although smaller, indirect investments are still expected for shale exploration through holding companies.