"All this has happened before... and it will all happen again." So begins a popular children's novel, which also could serve as the catch-phrase of the oil and gas business. Oil and gas prices, which had reached new highs signaling the beginning of another long-awaited new era for the upstream industry, peaked and faded, ending the year at levels that left most everyone disappointed. Perhaps the most dismayed and disappointed were those active buyers from the 2001 merger, acquisition and divestiture (MAD) market who paid transaction values implicit of a permanent shift in gas prices only to see a return to near 10-year averages by year-end. The 2001 market once again provided ample opportunity to aggregate, consolidate and reposition, but in hindsight, 2001 was defined by those with a desire to liquidate. Private companies, fund-sponsored companies and public companies with significant founder's equity all took advantage of the shift in price expectations to profitably monetize years of previous investments. At year-end, even those who had played the buyside and executed multiyear hedges to mitigate price risk found that a creditworthy counterparty is not always easily identified. Transaction volume and activity clearly placed 2001 on the downhill side of the megamerger boom that began in 1997. The upstream value of announced U.S. merger and acquisition deals, as measured by Randall & Dewey Inc., Houston, totaled $22.5 billion, down significantly from the 1998-2000 averages which were heavily influenced by the creation of the supermajors. (See Figure 1.) Even the pending Conoco-Phillips merger was unable to significantly move the mark as Conoco's U.S. upstream business represented less than 25% of that transaction's total value. The 2001 average price paid for U.S. proved reserves of $6.85 per barrel of oil equivalent (BOE) reflected higher values for asset transactions, but no overwhelming supermajor transactions with high stock for stock-implicit value. It was not unusual to see reserve values for transactions in the first half of 2001 in excess of $10 per BOE, with several large Gulf Coast and Gulf of Mexico deals topping $12 per BOE. These elevated values reflecting high futures prices in the first half of the year propelled the 2001 reserve value for asset transactions to an average of $6.21 per BOE. (See Figure 2.) This is the highest annual average value for asset transactions that Randall & Dewey has measured since its inception in 1989. U.S. asset-transaction activity totaled $4.7 billion, which is below the average of the past several years, but in line with the average when unusually scaled asset transactions like Altura and Elk Hills are excluded. Interestingly, international transaction value exceeded U.S. transaction volume for the first time since the evolution of the U.S. A&D business in the 1990s, if the impact of the supermajor mergers is excluded. Frenzied consolidation in Canada helped pace the non-U.S. upstream transaction volume to more than $55 billion. Few public Canadian independents from the capitalization ranks of $500 million to $1.5 billion remain to be gobbled up by their larger Canadian peers or by their increasingly active south-of-the-border counterparts. Several companies used transactional activity to help redefine their presence in the market in 2001. Phillips continued a multiyear path that will ultimately lead out of Bartlesville, Oklahoma. Arco-Alaska, Tosco and the pending Conoco merger have transformed Phillips into a player that can now consider a Unocal or Burlington to be nicely bite-sized. Amerada Hess is much more concentrated in the upstream E&P as a result of the Triton Energy and LLOG acquisitions. But no one added 2001 to a string of noteworthy years of transformation with the impact and surprising frequency of Devon Energy. Last year Randall & Dewey commented on the regularity of Devon's annual late-spring shopping excursions (Northstar Energy, PennzEnergy and Santa Fe Snyder) and speculated whether 2001 would see the string continue. But as May, June and July passed with no announcements, market-watchers began to wonder whether Devon had a "pat hand." August brought comfort as Devon acquired Mitchell Energy & Development and September brought surprise as the Anderson Exploration acquisition was announced-only three weeks after the Mitchell news. Two deals at once are never easy to digest, and the subsequent decline in gas prices may have increased the potential for heartburn. Private companies The pressures on public companies to grow quarter-by-quarter and year-to-year kept most from taking advantage of higher prices in 2001 to prune and consolidate their asset portfolios. Private companies, especially those funded by cycle-conscious institutional equity, felt no such reluctance and 2001 saw them early and often as net sellers in both the asset and stock market. Natural Gas Partners, EnCap Investments, EnerVest Management Partners and Yorktown Partners were among those who took advantage of higher-than-average prices to monetize portions of their portfolios. Of the public companies that were sold in 2001, the most common characteristic of the group was the presence of a single large shareholder (often the founder) influencing the decision to sell rather than buy in the elevated market. Mitchell, Anderson, Barrett Resources, Louis Dreyfus Natural Gas and HS Resources all were ultimately compelled to sell even though several had resisted previous overtures. Even the deals structured as cash and stock found that cash was the more valuable consideration as commodity prices waned. 2001 was also the year of the merchant-power developer in the MAD market. The Williams Cos., Calpine, Dominion Resources, Mirant and Questar were all active buyers as each attempted to balance the longer-term supply issues coincident with gas-fired-generator development. This increased market activity brought the transporter-downstream sector from 2% of buyer volume in 2000 to more than 24% in 2001. (See figure 3.) The relative activity of this sector will likely be significantly affected by the subsequent Enron collapse. Enron and its aftermath will significantly affect the MAD market in 2002. Enron-owned affiliates held several E&P investments in their portfolios and it would not be surprising to see each change hands in 2002. The failure of Enron to perform on its underwater hedge positions will affect several independents' debt levels, capital budgets and expectations of price-risk mitigation moving forward. Enron supported MAD-market activity as a capital provider, production-payment underwriter, hedge counterparty, gas-price speculator and a marketmaker in highly structured transactions. The fallout of the Enron collapse has impacted other capital providers to the MAD market with similar, but possibly not as speculative business lines. El Paso, Williams and Calpine have all scaled back their upstream acquisition activity with several announcing plans to sell noncore E&P holdings. Even GE Capital has backed away from its standard 99/1 financing structure to a more conservative 95/5. The cost of longer-term hedges will most likely increase as credit quality becomes a two-way issue. Future gas-demand growth is likely to be affected as merchant-power companies are scaling back on aggressive plans to build gas-fired generators. Evidence of the omnipresent asset food chain was becoming more abundant as the year ended. Conoco adjusted its portfolio in the aftermath of the Gulf Canada acquisition by selling significant domestic assets to growing independents. Devon has announced plans to sell $1- to $1.5 billion of assets to reduce acquisition-related debt. Kerr-McGee is selling since its acquisition of HS Resources. El Paso will use asset sales of up to $1.25 billion to recapitalize in the wake of Enron-related balance-sheet scrutiny. Pooling of interests Still absent from the U.S. asset market are the anticipated tail-end consolidation divestments from the supermajor mergers of 1998-99. The merger this past fall of Chevron and Texaco was the last big pooling-of-interests transaction and, as such, may be out of the market for yet another year. Overall asset availability appears to be relatively high entering 2002. Pooling of interests has now passed as a potential limitation of postmerger divestment activity. Its replacement is purchase accounting with the potential for "permanent" goodwill. This should have little impact on the upstream transaction market. It is unlikely that an E&P merger would result in the creation of significant goodwill unless and until equity values are elevated to the point that they reflect a significant premium over underlying assets. For many E&P investors, that proposition would be a welcome change. With commodity prices having retreated back to levels not far from decade averages of $2.30 gas and $18.50 oil, several historically acquisitive companies and management teams are tanned, rested and ready to take advantage of current market conditions. Even some A&D capital providers have reloaded and are primed to invest after selling in 2001. The longer-term mood of both market participants and Nymex traders would suggest that $3 to $3.25 gas and $20 oil are still solid benchmark expectations in spite of near-month weaknesses. Only the most distressed of sellers would currently accept transaction values reflective of prices lower than these benchmark levels. 2001 was supposed to be the year that confirmed that the gas market has moved to a new, permanent plateau. Oil prices were destined to stay solidly within the OPEC price band. MAD-market participants inflated transaction values appropriately, but gas-demand elasticities proved greater than anticipated, and external events swamped OPEC's near-term ability to control supply in the face of declining demand. At year-end, the industry remained cautiously optimistic. Declining rig counts should reduce future supply, and lower prices should spur incremental demand. "All this has happened before...and it will all happen again." M Gregg Jacobson is vice president, petroleum advisory, with Randall & Dewey Inc., a Houston-based acquisition and divestiture advisory firm.

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