Drivers of M&A activity in the energy sector in the coming year
M&A activity in general, and in the energy sector in particular, was relatively mute in the last year. Activity picked up towards the end of the year with BP's sale of its 51 per cent stake in its Indian solar power business to Tata, Repsol's acquisition of stakes in oil and gas fields in Mississippi, EDF's announcement to acquire Edison, and earlier this year Eon's planned acquisition of a stake in Brazil's MPX Energia. Despite that, 2011 overall was still a dull year for M&A transactions.
It is anticipated however for activity to dramatically pickup in 2012. The recent move by Cove Energy to put itself up for sale for an estimated $1bn has sparked renewed expectations for a much active year. The argument is that due to the limited ability of the smaller companies to raise adequate capital (especially given current circumstances in the capital markets) to finance their expansion and the development of new fields, they are increasingly turning to the bigger players with much deeper pockets and/or better ability to raise capital to acquire them and invest in their growth opportunities.
However, before one looks at the affordability or not of these acquirers to buy the smaller E&P companies or consolidate by merging with their peers , the fundamental questions that will determine whether we see increasing M&A activity are: Are current valuations right? Are the assets or shares fairly priced? Are they value-creating investments? Basically, is the price right? Oil prices have remained above $100 per barrel for awhile now and this has been reflected in the strong valuations of these companies and their assets. Perhaps this is partly the reason why deals have been so limited in the past year.
The next question is: How are these valuations expected to trend in the near future? One can argue that oil prices are most likely going to stay relatively high at above $100 per barrel, as Saudi Arabia recently confirmed that it thinks a reasonable price range for oil is at around the $100 mark. Further, with the potential crisis with Iran and its nuclear ambitions, which could lead to serious supply constraints, it would not be a surprise for oil prices to trend higher, making valuations much higher and possible acquisitions quite expensive.
Therefore, despite the anticipated increase in interest by the bigger oil companies to acquire and/or consolidate and their relative ability (compared to the smaller companies) to raise capital, there is the likelihood that these acquisitions might simply be too expensive and not value-creating investments. As a result, we might continue to see weak activity in M&A deals in the energy sector.