OIL and gas merger and acquisition activity was strong in 2010 and has continued in 2011. , Total global industry transaction value topped $266billion in 2010, up 33% from 2009.
The number of deals went up 13%; and deal value rose strongly in each of the four industry segments (upstream, downstream, mid stream and oilfield services), with total upstream transaction value reaching a record high.
A major contributory factor in this growth has been a significant increase in investment in unconventional oil & gas reserves. Canadian tar sands, US shale gas and Australian coal bed methane have all seen significant investment and significant numbers of joint ventures being entered into by the leading energy players.
In addition to this, the recovery in the oil price to over $100 per barrel means that there are now a broader range of projects that have become economically viable. These projects may be in locations remote from the markets that they will supply, be in harsh operating environments or require major new infrastructure to be developed. Consequently they require significant capital investment and may well favour a collaborative approach.
In the April 2011 Ernst & Young Capital Confidence Barometer, 37% of oil & gas companies surveyed indicated that they are seriously considering a joint venture (JV) in the next 12 months. It is therefore anticipated that the number of new JVs being entered into will continue to be high for the remainder of 2011 and beyond.
JVs are a well established feature of the sector.
They are typically less risky and are easier to unbundle than full organisation mergers. Given the scale of organisations within the industry, anti-trust concerns and the importance of national energy security, JVs are a useful way of gaining the benefits of collaboration without the economic and political risk associated with a merger.
There are a number of drivers behind why JVs are used so extensively within the sector:
Capital intensive: upstream projects can be too big for a single company (even a super-major) to finance on its own. Many of the larger liquid natural gas (LNG) and deep water projects fall into this category.
Risk concentration: the risk profile attached to large-scale exploration and production projects is such that no company may wish to take full exposure.
Access to technology: complex or frontier developments may require proprietary technology that requires the owner to have a stake.
Access to resources: the legal owner of resources may not have the capital/technological ability to develop them to their maximum potential.
Supply chain optimisation: downstream supply chains may be optimised across disparate geographies by pooling assets. Many of the refining JVs are based upon supply chain and market supply optimisation for the various participants.
Market positioning/portfolio optimisation: pooling assets may allow the JV to develop a market-leading position in a particular geography (downstream) or product (chemicals) and enable a portfolio to be optimised across both asset pools, generating a value uplift from prioritising bigger assets. In an increasingly cost-focused climate, economies of scale are critical to success. Partnering may help achieve these.
Regulatory requirement: some countries require foreign companies to partner with local entities if they are to enter that market.
Political sensitivity of energy security: this means that JVs as opposed to acquisitions/takeovers may be more appropriate.
The past few years have seen high numbers of oil & gas JVs being entered into, particularly in the upstream where the cost, risk and technology issues clearly favours a collaborative approach on the largest projects
Oil and gas companies can be positioned somewhere along each of the following four continuums:
Asset/reserves seeker through asset/reserves holders.
Low access to capital through high access to capital.
Lagging technologists through leading technologists.
Low appetite to risk through high appetite for risk.
If a company is on the right-hand end of all four continuums, then they may have no need to partner and may wish to proceed with a project as a sole venturer. If, however, it is positioned towards the left-hand end of any of these continuums, then it may well be necessary or appropriate for it to partner.
JVs are an inherent part of the oil & gas industry and are likely to remain so for the foreseeable future. When managed well, they can deliver real value to all stakeholders.
However, when things go wrong, they have the potential to destroy shareholder value, with arbitration and legal proceedings being a costly, time consuming distraction for the management of both the JV and the partners.
To avoid this, companies should consider the following factors when entering into JVs:
Transparency, openness and honesty between the partners. Understand your partners business drivers, culture and their rationale for entering into the joint venture.
Thorough financial and tax planning. Ensure that all partners are aligned on the likely costs and benefits of the joint venture across a range of likely and less likely scenarios.
Ensure you have identified potential counterparty risk scenarios and that you have implemented appropriate protective measures in relation to both your JV partners and your critical operational contractors.
Identification of and planning for all potential dissolution scenarios. Consider what issues may potentially lead to a need to dissolve the joint venture. Discuss this openly with your partners and ensure that provisions for all realistic or likely scenarios are documented and contained within the agreement.
A robust, legally sound agreement that contains provisions for all of the above.
Ally Rule is a transaction advisory services partner at Ernst and Young
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