May 2018
In 2017 we saw a continuation of the upturn in upstream M&A which began in late 2016. The oil & gas industry has been through a sustained period of focus on cost cutting but, as the oil price stabilises, many players are now seeing an opportunity to refocus on growth. In this atmosphere of cautious optimism, they are seeking to rationalise their portfolios in preparation for the coming years – balancing field life, development profile and geopolitical exposure. We think these factors will support the continued upward trend in upstream M&A in 2018.
In 2017 deal making in the global oil & gas industry saw its first annual growth since Brent dropped below $40 in 2015. Whilst E&P companies still account for more than half of deal volume, the buyer universe continues to expand with traders and financial buyers growing their asset bases. Indeed, private equity firms accounted for $41.9bn of deals in 2017. PE and financial buyers continued to feature prominently in the African M&A market – a trend which looks set to continue. In its global oil and gas transactions review 2017, Ernst & Young says that its Capital Confidence Barometer showed that “nearly 50% of respondents are expecting increased competition for assets from PE buyers”.
The trend across Africa has been characterised by a low number of high-value deals ($2.7bn in 2015 increasing to $4.9bn in 2016, with a further increase in deal value seen in 2017), with the majority of the value in the upstream sector. The back end of 2016 was particularly positive, reflecting the global upturn trend that also began in late 2016.
Parties are showing a readiness to adopt new deal structures and operating models in order to achieve successful outcomes. They have been adopting more flexible consideration structures; departing from traditional approaches to allocation of liability for decommissioning costs; alliances between co-venturers aimed at maximising value by deploying specialist expertise; exits through joint ventures; and varied sources of upstream finance alongside the continued presence of private equity.
Against the backdrop of lingering price uncertainty, there has been an increased use of consideration structures that involve a deferred element contingent on the oil price, further discoveries or reserves, or significant project milestones. Similarly, we have also seen the use of royalty and similar arrangements, whereby a seller retains some cash flow interest in an asset; and deals being “sweetened” by giving purchasers options to acquire additional interests.
Decommissioning
In recent deals in mature basins globally, we have seen that decommissioning can be a sticking point in private M&A transactions, notably in the UKCS with its onerous statutory decommissioning regime, where the price that a buyer can offer may be adversely affected not only by the significant cost of decommissioning, but also by the cost of providing security to the seller and co-venturers for decommissioning liability. Decommissioning issues have featured less prominently on transactions in Africa and generally sellers have continued to pursue a clean break strategy. Domestic pressure to hold decommissioning funds in local banks, and certainty of funding at the time of decommissioning, remain a consideration in certain jurisdictions.
Alternative approaches
The split operatorship model is being applied in more prospective basins, for example in Mozambique where Eni will continue to lead the Coral floating LNG project and upstream operations, with ExxonMobil leading the construction and operation of all future liquefaction and related facilities. In ever diversifying operating environments, it is becoming harder for any single operator to be a master of all things. Therefore, upstream players have been forming joint ventures under which, for example, one party acts as operator for exploration operations, while another party acts as operator for development and production. This could also work with decommissioning operations. The purpose of this approach is to ensure that the strengths of each co-venturer are effectively deployed to maximise value from the relevant asset.
Financing deals
Whilst less traditional sources of finance continue to enter the market (including prepayment and commodity streaming deals as well as bilateral facilities from debt funds) there has also been a significant return of bank capacity as the market stabilises. Also, debt deals are changing – we see hybrids of reserves based lending with both acquisition finance and project finance; and in some cases majors have been willing to provide debt too, alongside senior banks but with associated offtake and hedging arrangements. Take for example the financing of Assala Energy's acquisition of Royal Dutch Shell's entire onshore oil and gas assets in Gabon, which was structured as an acquisition/borrowing base facility hybrid with a bespoke, tailored security and covenant package.
The next challenge is to consider how contractor balance sheets can support development financing.
Jurisdictions
Just as there is no one size fits all approach to Africa, there is no one trend fits all approach. In 2016 the largest deals were in Egypt, Mauritania, Senegal, Gabon and Nigeria, demonstrating that both mature markets and frontier jurisdictions such as Senegal are gaining international attention.
Certain jurisdictions such as Nigeria saw a reduction in production. Total Nigerian deal value has tailed off significantly since the busy round of disposals in 2013/14. However the strong geological opportunities, the easing of tensions in the Niger Delta and pipeline of potential deals, suggest that 2018/19 may again see Nigeria rise up the league tables.
Other jurisdictions have been taking active measures to try to encourage investment, including for example Egypt, which has adopted new laws to encourage and promote its LNG market.
Looking ahead
If the oil price will be “lower for longer” the deal structures described above will evolve and become more widespread. The market is more fractured and complex than it was in an environment of $100 oil. The plurality of buyers, sellers and funders requires bridging tools to accommodate value gaps and the requirements of new entrants who are not traditional industrial and financial players.
While the number of discoveries in Africa has shown a decline in recent years, it should not be overlooked that 5 out of the top 10 discoveries in 2016 globally were in Africa. Coupled with major discoveries in the Mediterranean in 2015, such as the Zohr field offshore Egypt, the potential for ongoing M&A activity and a return to exploration and development opportunities looks promising.
The last three years have demonstrated the resourcefulness of the oil & gas industry. This is reflected in the new deal structures, operating models and sources of finance, which will play their part in reshaping the industry for the next generation.
About HSF
Herbert Smith Freehills has one of the world's leading energy practices, bringing together 300 energy specialists across our 27 offices to meet all your legal services needs globally.
We are proud to act across all elements of the value chain and advise the full spectrum of sponsors, lenders and investors. This platform gives us a finely calibrated perspective on the opportunities and challenges in the sector. Our objective is to drive service delivery efficiencies and improve quality for clients. Investment in technology and our alternative legal service offices and lean approach to legal project management has helped achieve this together with significant savings for our clients.
Global instability, resource nationalism, regulatory changes, tighter environmental requirements and financial pressures can lead to a range of problems for energy projects and transactions. We analyse, advise and develop strategies with real-sector expertise to resolve a diverse range of disputes along every stage of the supply chain to mitigate risk and stay competitive in the market.
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