For the rest of 2015 and into 2016, experts expect A&D deal flow to go even quieter in the current unstable oil price environment, although there could be bright spots for quality natural gas assets. This view pervaded discussions at Oil and Gas Investor’s recent A&D Strategies & Opportunities Conference held in Dallas, where more than 500 transaction players and experts gathered in early September to discuss the market.

Bill Marko, managing director of Jefferies LLC, minced no words about the uninviting landscape of A&D in 2015. “It’s brutal,” he said.

A flurry of deals in May and June, prompted by briefly rising oil prices, was short-lived and collapsed, he said.

With the more severe downturn in crude market value, deals may become even less common in an already drab year. “I don’t think we’ll see a lot of oily deals,” he said. “No one is going to sell at $45 oil unless they have to.”

To call 2015 a year of change is “the understatement of the year,” he said. Deal activity and values have fallen into a ravine. In a typical year, deal volume through three quarters ranges from $50 billion to $75 billion, he said. Year to date, the market has produced roughly 50 deals worth $20 billion. In 2014, by contrast, nearly 250 transactions generated $98 billion in deals.

While demand remains sharp for quality assets, uncertainty due to the recent price downturn could stall deals that came to market in the late second quarter of 2015 and early third quarter.

Still, the U.S. energy industry has persevered in the recently dubbed “lower for longer” era.

“I think we surprised Saudi and OPEC and others with what we were able to do,” Marko said, referring to E&Ps’ rapid de-escalation from mass production to more efficient production.

While U.S. oil volumes are down about 50,000 bbl/d, rig counts have fallen far more substantially, from roughly 1,900 to 871 as of the week of August 31.

“A year ago it was about fast, this year it’s about efficient,” Marko said, adding that estimated ultimate recoveries in some plays have doubled, quadrupled or more.

E&Ps have also survived the low oil price environment by virtue of large cuts in service costs. That might not last, however. “I don’t know that service companies can sustain it forever,” Marko said.

All about the Permian

Despite the glut of oil and drop in price, oil assets have held their traditional market share. The commodity has accounted for roughly 75% of deals by volume in the past two years.

And, overall, unconventional deals still rule in the U.S. In 2015, unconventionals accounted for 80% of transactions. Fewer and fewer operators are drilling vertical wells, Marko said.

The leader of the pack for transactions, far and away, is West Texas.

“It’s all about the Permian,” Marko said, noting that the basin has had 25 sales and JVs in 2015. The next closest play in number of deals is the Eagle Ford, with seven transactions.

While corporate M&A is gaining momentum, asset deals continue to be the chief driver of transactions. Such deals are “cleaner” than deals involving merging with or absorbing another company, and are less complicated.

“Assets are generally cleaner,” he said. “You know what liabilities there are.”

However, Marko noted that international investors tell Jefferies they want to buy assets with a team. The key will be buying assets and providing incentives to keep a team in place, he said.

Among potential overseas investors, “Asian sovereign wealth has done more looking at the U.S. so far. We keep wanting and waiting for Middle Eastern sovereign wealth,” he said.

Getting bank

At the beginning of 2015, E&Ps generated record financing activity with equity offerings in the first quarter totaling $13.6 billion—more than in all of 2014.

Marko said companies were smart to grab liquidity while they could. Now they are staring down serious leverage concerns. They are increasingly uneasy about the impact to liquidity from reduced cash flow and borrowing base redeterminations this month.

“Hedging is helping a lot of people, but hedging is rolling off,” Marko said.

Typically, a borrower’s revolver maintenance has a leverage covenant of 4x. In 2015, Marko estimates, leverage for small caps will increase from an average 5.2x to 7.6x. Mid-caps will also rise to 4.7x. MLP leverage is expected to increase to an average 9.3x.

LNG’s appetite

Under pressure, deals will have few bright spots. Natural gas may be one of them. Quality resources should attract attention from investors to meet the needs of LNG suppliers.

The Haynesville, for instance, has greatly improved its EURs and in August attracted a major deal. Jefferies advised GeoSouthern Energy Corp. on the purchase of Encana Corp.’s assets in North Louisiana for $850 million.

GeoSouthern purchased 112,000 net acres of leasehold as well as 49,000 acres with mineral rights. As part of the deal, Encana reduces its gathering and midstream commitments by $480 million.

Encana developed the assets for a decade, Marko said. Now, GeoSouthern will update drilling and completion techniques and further develop the play.

“Encana knocks down $850 million,” Marko said. “I think there are other things like that out there.”

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