14th November 2017
In any resource based industry, it is a common practice to adjust existing asset portfolios by Mergers & Acquisitions (M&A), either selling or buying individual assets, regional portfolios or indeed entire corporate entities. Final Investment Decisions (FID) are made for assets involving 15-35+ year investment cycles, based on incomplete understanding of the subsurface geology, project costs, oil and gas demand and prices, availability of finance and most importantly, production performance - and things then change. At a London SPE evening seminar earlier in 2017, GCA's Chris Rachwal proferred several justifications for acquiring upstream assets and triggered a lively debate. Here he expands on some of his key slides from that evening.
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As he opened the subject Chris addessed was what might be the justifications for acquiring upstream assets (Fig 1).
Fig 1: Reasons for undertaking upstream M&A
As with any industry sector, portfolio adjustments are logically made to combine the “best of both” in terms of skills, capabilities involving complex engineering, variations in cost of capital and corporate attitude to risk tolerance. Bringing efficient skills from one operating environment and applying them to a new market segment, e.g. low cost sub-sea tie-back developments, naturally adds value to a project and thus to vendor and buyer alike.
As assets mature into mid/late life, the original Operator's skills in designing and executing complex, new field developmenst are frequently less suited to managing late life, highly cost-sensitive operations. Mature, and typically shrinking, assets become non-core to many larger companies. Subject to managing the complex legal and tax issues regarding abandonment, they may be better suited to companies which specialize in optimizing mature field management of many small reservoirs while minimizing overheads. Reconditioning such mature assets may extend the field life by 10+ years and achieve more than a doubling of the Reserves evident at the time of the transaction. Defining how much upside there may be, and who gets what share of its economic rent, is all part of the delicate negotiation; often leading to late nights and weekend working.
Another major driver of asset divestments occurs post a major corporate merger, when the new entity may involve 60-80% more active operating countries, experience conflicting calls on capital, staff, and especially, executive management time. In the case of many North American independents, entire international portfolios have been sold off to help fund capital-intensive unconventional projects in the USA and Canada, providing high quality opportunities to those investors who prefer not to tangle with the intensely competitive marketplace in North American unconventionals.
In GCA’s experience, those companies that rely on “other” justifications for asset acquisitions frequently struggle to screen which opportunities to go after or to be able to submit winning bids that also create long term value. As a rough guide, we estimate that only 1 in 20 possibly opportunities that cross a New Business Development (NBD) manager’s desk should trigger a thorough due diligence process. Limited, but tightly disciplined, analysis of some/most of those on offer may help refine a company’s strategic growth objectives and thus allow the NBD team to refocus their efforts and get home at a decent time each evening!
Having established the main sell-side or buy-side drivers for entering into a transaction process, successful execution of any deal is influenced by understanding best sell-side and buy-side practices and avoiding most of the many pitfalls that exist. In GCA’s experience, these best practices apply equally to conventional oil companies and to transactions involving Government Licence Rounds as large as those we have been involved with in Iraq, Kuwait, Brazil, Venezuela and many more.
Good sell-side practice (Fig 2) often comes about from fully anticipating the prospective buyers’ legitimate needs and timings, then providing a process, documentation and flexible deal-making that allows both parties to bring negotiation to a successful conclusion in a timely manner.
Fig 2: Good practice and potential pitfalls for the sell-side team
Efficient buy-side teams will have developed well-honed practices which concentrate on the key areas of value and skills/knowledge retention but also address vital risk components such as legal and environmental liabilities (Fig 3). The timescale for due diligence evaluation is often only a few weeks to a few months, hence emulating what one US Major did many years ago in assembling a 200+-strong evaluation team in 6 different locations, is not recommended. A member of that team informed us that after 3 weeks of preparation, numerous logistical and conflicts issues were encountered and none of them even made it to the data room before management cancelled the effort.
Fig 3: Good practice and potential pitfalls for the buy-side team
The fundamentals of creating lasting value in buying assets are not unique to the oil and gas industry. Whilst working alongside management consultants Boston Consulting Group (BCG), the following diagram (Fig 4) was presented to our mutual Asian NOC client. It left a lasting impression of being an accurate understanding of the key ingredients for success and 20+ years later, it still appears to be valid.
Fig 4. Key ingredients for buy-side success
Two “Jokers” that were not included in the original diagram, being specific to oil and gas transaction would be:
A) Giant new oil/gas find occurring mid-way through the transaction
B) Major commodity price swing in the same timeframe.
In late 2014, GCA was involved in a very well managed Norway offering with Buyers and Sellers working well in partnership towards a deal. The oil price collapsed from more than $100/Bbl at the initial offering stage to less than $50bbl prior to the final bid deadline. Most bids collapsed, one party did eventually go forward on the basis of contingent payments in the event of oil price recovery, but by end 2015, even that deal fell apart and the perfectly good assets were not sold.
Achievable Strategic Plan
It is self-evident that the world has lots of market segments, thus developing one's own understanding of these operating environments and their “fit” to one's strategic objectives is essential to achieving sustained success.
There is no unique definition that GCA is aware of for defining global E&P segments for M&A strategic planning, but just to provoke some debate, one highly stylized macro-view of possible investment regions is shown in Fig 5. It represents a current snap-shot which will change with time as exploration succeeds and other regions mature.
Fig 5. One suggestion of global E&P segments
Naturally, as one focusses in on any given niche, there will be more refined technical and commercial segmentation of the opportunities. Each current asset owner or potential buyer should be able to define where they have a competitive edge in dealing with economic and technical issues when presented by each basin or play type. Good due diligence should seek to identify marriages between the buyer's core competence and the critical needs of the opportunity in order to deliver real value. Fig 6 gives an example: a conceptual schematic of the current Egyptian market place.
Fig 6. Indicative stress analysis of opportunities within the Egyptian E&P segment
Execution Team, Capturing Value Post Transaction
Industry experience suggests that capturing value in any acquisition is often either achieved or lost in the first year or two post-deal closure. A key factor in capturing value is identifying key people in both the acquired and acquiring entities, plus empowering them with a clearly laid out value plan. This plan should include much more than chasing “synergy” by simply eliminating duplicate costs and functions and by closing a few facilities.
Jeffrey Krug (Feb 2003 issue of Harvard Business Review) quotes typically 40% executive losses within the acquired entity within the first two years post a merger, but also records significant and sustained turnover in staff transferred from the acquiring company . He goes on to explain the tough environment that change of ownership often creates and the potential value of retaining key incumbents.
Diversify or Look Overseas?
In the technically complex world of E&P, most companies seeking to grow their portfolios by acquisition/merger either take an established business model into new regions (including new countries) or diversify their business model within their established heartland. Attempting to both obtain new skills and also operate in a totally new business environment at the same time more than doubles the risk.
Apache Case History
A good example of an established mature field Operator taking its skill sets of low overheads and fast decision making into a new operating environment is that of Apache Corporation’s entrance into the UK North Sea in 2003. Apache had long established core skills for managing large, mature offshore platforms in the Gulf of Mexico. These included finding opportunities to sustain production with numerous incremental projects to de-bottleneck processing while adding infill wells and also bringing on behind-pipe resources. When BP reviewed the mature giant Forties field (on production since 1975) production had declined from a peak of 500,000 barrels of oil per day (BOPD) in 1979 down to ~40,000 BOPD and Apache was an obvious candidate to take on the challenge of turning around this significant asset.
Forties field contained between 4.2 and 5 billion barrels of oil originally in place in a complex series of turbidite channel and overbank sands. Water injection had helped recover a significant percentage of the in-place volumes by 2003. However, Apache was able to bring a fresh perspective to locating by-passed pay in existing wells, later augmented by new 3D and 4D seismic data sets to identify un-swept reservoir compartments.
Apache was fully aware of the challenge of absorbing a significant incumbent Forties team, however in a personal communication, one senior Apache executive has said they underestimated the challenge of converting incumbents to the Apache methods and procedures. More significant in terms of capturing value in the first year was the unexpected backlog of corrosion and maintenance work needed prior to starting up infill and work-over operations in order to reverse natural production decline. Converting this challenge into an opportunity, Apache instigated many platform upgrades, tied-in Bacchus and Tonto oil fields (providing valuable fuel gas as well as improving OPEX/Bbl) and added a modern new platform bridge linked to an existing 1970’s platform. Apache now reports over 90% production uptime on Forties, one of the oldest operating oil fields in the North Sea whilst achieving 43,000 BOPD from Forties/Bacchus/Tonto (source Oil & Gas UK) in 2016.
In the absence of a clearly defined strategy aligned with a company’s core competencies and an execution plan to capture value, there is a significant risk that a Business Development team tasked with achieving X barrels at Y price deck and Z discount rate will under estimate risks in order to achieve the goals set. There are numerous historic examples of achieving an acquisition which had little or no chance of creating value as there was an asymmetric risk/reward position, i.e. teams can close the deal but not be held accountable for delivering long term value.
The M&A market place normally reflects this asymmetry with large bonuses on offer for overachieving on the sell side, but very rarely is such largesse available to reward buy side teams.
Chris Rachwal has been involved with M&A at GCA for over 30 years. Contact him directly for further discussion.
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