Lawyers in the oil and gas sector are optimistic about the potential for mergers and acquisitions, thanks to improving profitability and stability. However, they note that there still is a disconnect between buyers and sellers regarding valuation.
Pat Maguire, vice chair and Calgary managing partner at Bennett Jones LLP, describes the market for M&A in this sector as “stable with positive indicators.” He notes that oil prices have been reasonably strong, and many oil and gas companies pay down a lot of debt and buy back shares.
While there has been some consolidation through M&A activity in the first half of the year, Maguire
says it “was probably slower than some people would have guessed.” He sees a more robust market and M&A momentum in the second half of 2023. Still, he notes that dealmaking is likely being balanced with capital investment being deployed toward efficiency and decarbonization of existing production instead of taking on new projects.
“I think sellers are looking and expecting higher commodity prices in the future, so they are holding off a bit unless they absolutely must sell,” says Tom Collopy, a partner with MLT Aikins LLP based in Calgary. “That is stifling M&A a bit.”
Collopy and others working in the sector say that as oil prices remain stable, it becomes clear that fossil fuels are here to stay despite net-zero carbon goals, especially as decarbonization efforts increase.
“We’re just seeing a combination of geopolitical events – such as the global economy and the war in Ukraine – creating some dislocation between buyers and sellers,” says Peter Danner, partner with Torys LLP in Calgary. “At the same time, companies are cash-rich as they’ve remained disciplined and channelled free cash flow toward dividends and share buybacks rather than right into M&A activity. But that could soon change.”
Pricing for Canadian oil is also improving, with the differential between West Texas Crude and Western Canada Select significantly narrowed – from more than US$30 per barrel in November 2022 to about US$18 per barrel at the end of August.
Brian Bidyk, a partner at McCarthy Tetrault LLP, notes that in bleaker times just a few years ago, insolvencies in the industry led to a “lot of forced M&A,” but that has changed as oil prices and producer profits remain stable. “We’re seeing more opportunities for deals to get done,” he adds, with activity expected to increase this fall and into the new year as “buyers and sellers are getting a lot closer together on their thinking on valuations.”
Bidyk’s colleague at the firm, Kerri Howard, agrees, noting that balance sheets are more robust and there is a focus on expanding core assets. There is also a focus on new technologies, especially in the clean energy space, in areas such as carbon capture and sequestration.
Howard also notes that even when there is a valuation gap between buyer and seller, “vehicles such as earnouts and success payments are available to create a bridge.” There’s also been the increased use of representation and warranty insurance, especially if private equity is involved, so that buyers can mitigate risk.
Brendan Sawatsky at Fasken Martineau DuMoulin LLP in Calgary points out that stability and profitability in the O&G sector “cut both ways” regarding dealmaking. “It might be a good time to sell, but if things are going well, there may be no need to sell, and [would-be sellers] can continue to grow their assets.”
Still, he thinks that these days, “there is a closer meeting of the minds on valuations” if a deal is to be made, especially as the players tend to be well versed in production numbers and how the industry is structured.
A report earlier this year by Deloitte Canada suggests that prospects should be more robust soon, thanks to stable oil prices, well-performing companies, and the pressure to deploy capital.
It notes geopolitical events and economic uncertainty contributed to volatile energy prices across the globe in 2022. Despite record energy prices and low valuations, M&A activity in the O&G sector fell to its lowest since 2008, partly thanks to increased capital discipline. But that is changing.
Says Andrew Botterill, national oil, gas, and chemicals leader at Deloitte: “OPEC is making moves to stabilize oil prices around the $US80-plus level [Brent and WTI crude per barrel], and we’ve seen strong cash flows, so while energy companies have recently been happy to roll out value to shareholders in the form of dividends, I think we’re going to see some pressure to use those strong balance sheets to support dealmaking.” He expects another busy spell of foreign investment soon.
“I think we’re going to see companies focused on high-value areas that fit in with the company’s long-term strategies and show synergies and cost efficiencies,” Botterill says, noting that players are still sensitive to recent volatility. “Companies will want resilient, strong portfolios, not just grow for the sake of growing.”
Corporate mergers and joint ventures should continue to outweigh asset acquisitions as companies look to consolidate production and optimize operations. Deloitte’s report points to several drivers of strategic M&A.
These include the acquisition of natural gas processing and capacity, creating partnerships and strategic alliances in shale gas in areas like the Montney Basin in Alberta and BC, compliance with clean-energy goals, especially those involving hydrogen, ammonia, nitrogen, and sustainable aviation fuel; and gaining scale and commercializing low-carbon businesses, as O&G companies increasingly look for sellers with a higher ESG profile. (Over the past five years, in more than 70 percent of deals, the ESG score of the seller was higher than that of the buyer.)
Looking at dealmaking in different parts of the energy sector, Deloitte’s Botterill says that downstream is “going to continue to be an exciting part of the M&A picture because so much of the investment there will focus on decarbonization – it’s going to be about developing lower carbon fuels, biofuels, and sustainable aviation fuel.”
Midstream is another sector that could be ripe for dealmaking, as it’s all about being as efficient as possible and having strong balance sheets.
As for upstream dealmaking activity, the Deloitte report notes that M&A activity declined in 2022 to the lowest levels since 2005, excluding the pandemic year. According to the report, this fall in dealmaking likely reflects the shifting priorities toward investing in clean-energy M&A.
Botterill says that the oil sands component of upstream production will likely not see a lot of M&A activity for a couple of reasons. Firstly, “we’re down to a very few number players, and secondly, there is more investment in projects with a decarbonization component.” Existing players in the oil sands will likely focus on making their production efficient and cleaner over the long life of bitumen assets.
Fasken’s Sawatsky agrees that the midstream sector in the O&G industry – which includes the processing, storing, transporting, and marketing of oil natural gas – is likely to be active.
“With upstream, for example, companies might not think it’s the right time to invest in producing more oil, especially with net-zero considerations,” he says. “But midstream is something that will always be here, as long as there is oil and gas production.”
Another trend around M&A in the oil and gas sector is the increasing participation of Indigenous communities. While much of this is a product of reconciliation objectives, the partnerships with First Nations also represent a practical approach to energy development and ownership, says Danner at Torys.
“It’s a great alignment of interests between anyone impacted by oil and gas projects,” he says. Danner adds that government support of Indigenous participation in such partnerships, such as through the Alberta Indigenous Opportunities Corp., has helped.
One example is the AIOC’s support for a landmark deal between 23 Indigenous communities and Enbridge in purchasing an 11.57 percent working interest in seven major pipelines within the Athabasca oil sands system in northern Alberta. The government corporation provided a $250 million loan guarantee to secure the Indigenous group’s financing in the $1.12 billion deal.
“There’s a lot of interest in developing those alliances, and that has an impact on potential M&A activity.”
The recent US$14 billion cash-and-debt deal that would see Enbridge purchase three US-based utility companies – The East Ohio Gas Company, Questar Gas Company and its related Wexpro companies, and the Public Service Company of North Carolina – from Virginia-based Dominion Energy is just one sign that the oil and gas sector is embracing the energy transition that is underway.
Enbridge says the deal will double the scale of its gas utility business and balance its asset mix evenly between natural gas renewables and liquids. The company’s earnings mix is about 60 percent crude oil and liquids and 40 percent natural gas and renewable energy. The Dominion deal, expected to close in 2024, would bring that closer to 50–50.
The purchase also fits with the company’s bullish outlook on natural gas – even as the world aims to reduce emissions from fossil fuels to tackle climate change. Enbridge says all forms of energy will be required for a safe and reliable energy transition.
Says Danner: “Oil and gas producers are embracing energy transition, and Canadian players have the opportunity to be a preferred supplier of responsibly produced hydrocarbons to the world.” And that could involve both direct investment and M&A.