Sustained low prices could reshape oil sector M&ANews // January 22, 2015
Fitch Ratings says sustained low oil prices could continue to buoy the M&A market beyond the flurry of opportunistic deals we have already seen.
"Low prices for an extended period could lead to more acquisitions of smaller, potentially distressed companies by larger ones, while reducing the major oil companies' ability to finance their operations through disposals," said Fitch. "Buyers would also be more likely to finance deals by raising equity rather than borrowing, particularly for larger acquisitions.
"The combination of lower operating cash flows, fewer disposals and some potential acquisitions could put major oil companies' credit metrics under pressure. But the impact would depend on how they respond, as some might choose to cut capex and exploration expenses, while others might decide to operate with higher leverage, which could lead to downgrades if sustained. But these changes are unlikely if oil prices quickly rebound to above US$80 a barrel, as happened in 2009.
"Smaller companies are typically more vulnerable to low oil prices due to higher leverage, higher production costs and poorer access to external funds. Some may find it increasingly difficult to finance their big exploration and development programmes through bank loans and bond issues in the current environment, and their credit metrics could significantly deteriorate if oil prices remain below US$60/bbl.
"This could make such companies attractive targets for larger ones with better access to funding and technology, and which have been struggling to increase their reserve base for several years.
"National oil companies (NOCs) with deep pockets, such as Thailand's PTT Public Company (BBB+/Stable) and Malaysia's PETRONAS (A/Negative), and private equity firms could also become more active buyers.
"But NOCs would mostly focus on medium-sized producers rather than small, distressed companies as healthy balance sheets remain a priority for many of them.
Lower oil prices also pose a hurdle to M&A among major oil companies by limiting their ability to sell assets.
"They have been increasingly reliant on disposals to finance growth or reduce their debt burden in recent years. For example, Total (AA/Negative) raised around US$12 billion through assets sales in 2012-3Q14 and intends to raise US$10 billionn in 2015-2017. Shell (AA/Stable), BP (A/Stable) and BG Energy (A-/Negative) also have significant disposals programmes.
"This strategy would probably need to be reconsidered if oil prices remain depressed because asset valuations would fall and buyers have generally been small- or medium-sized companies building local production portfolios. These companies would find it harder to attract finance to support such deals.
"We view US$80/bbl as a long-term price equilibrium based on the marginal cost of production," said Fitch. "A recovery is likely in 2H15 but it is impossible to be certain of its timing. A lengthy slump would put pressure on many companies, potentially making them attractive targets; a sharper recovery will reduce the need and opportunity for M&A."