ExxonMobil’s Permian interest unlikely to produce M&A gusher

Data InsightDealspeak 15 May

ExxonMobil’s Permian interest unlikely to produce M&A gusher

ExxonMobil’s [NYSE:XOM] reported interest in Pioneer Natural Resources [NYSE:PXD], coupled with a greater desire for energy security after Russia’s Ukraine invasion, initially sparked hopes of a blowout in dealmaking.

But such a mega transaction in the Permian Basin — Pioneer holds the largest contiguous acreage there — is unlikely to trigger a wave of M&A activity because a valuation gap persists between buyers and sellers, said oil industry executives and advisors.

No broad consensus exists about the future of oil and gas prices, according to Stephen Szalkowski, an energy-focused partner at Latham & Watkins. Potential sellers tend to believe prices have stabilized and guarantee a steady source of cash flow, whereas buyers expect continued market volatility, he said.

On top of that, most upstream companies continue to focus on profitability instead of growth following the US shale industry’s booms and busts between 2010 and 2020. US shale properties have become cash-generating assets that help fund share buybacks and dividends, John Rielly, CFO of Hess Corporation [NYSE:HES], said last month at an energy industry event in Toronto.

“The Permian is the best and cheapest basin in the world,” Szalkowski said of a resource where producers can break even at USD 20 oil. “Why would companies sell those assets?”

The limited availability of Permian targets has made dealmaking there “incredibly competitive,” added Zach Fenton, president and co-founder of UpCurve Energy.

Running dry

Since reaching a high in 2018, M&A activity in North America’s upstream and midstream oil and gas sector has dropped annually to 89 deals worth USD 63.1bn last year, according to Mergermarket data. Those are the lowest levels since 2016, when an oil price plunge led to several bankruptcies.

Compounded by another oil price collapse at the start of the pandemic – and more bankruptcies – many banks and alternative lenders such as HPS Investment Partners and Blackstone Credit pulled out of the sector, leaving fewer financing options.

Only about 15 lenders actively service the industry today, down from 30-40 banks a decade ago, making it a lot harder to finance USD 2bn-plus deals than before, said one bank lender. When making acquisitions, upstream companies such as Chesapeake Energy [CHK.O], which paid USD 2.76bn in cash and stock for Chief E&D last year, “are not putting in a lot of debt,” any more, said the lender. Many now keep leverage levels to below 1x EBITDA from 3x to 4x a few years ago.

Midstream bright spot

Any dealmaking is likely to be in the midstream sector. A portion of the pipelines and storage facilities in the Permian Basin were built and are owned by private equity firms that are at the end of their investment cycles and might be looking to exit, said Vern Yu, Enbridge’s [NYSE:ENB] then CFO, at the Toronto energy event.

Midstream buyouts jumped from USD 2.1bn in 2017 to USD 15.6bn in 2019, only to drop to USD 3bn in 2020 at the onset of COVID-19, according to Mergermarket data. Midstream dealmaking overall, which also includes acquisitions by strategics, hit a peak of 57 transactions in 2017 and USD 92.9bn worth of deals in 2018, before tailing off.

Potential buyers of Permian Basin midstream assets are mainly large midstream companies, an energy-focused banker said. Enbridge, for example, is one company seeking such assets.

Realistic multiples for US midstream assets hover around 4x-5x EBITDA, compared with the historic 7x-9x, as the collapse of Master Limited Partnerships (MLPs) means there is no longer a ready-made group of buyers with available capital, the energy-focused banker said.

Additionally, some midstream assets are not large pieces of infrastructure or long-haul pipelines that can demand take-or-pay or long-term contracts and instead depend on local drilling and production, making them “harder to value,” the banker said.

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