On 18 September 2018, I attended a roundtable discussion with Bracewell (UK) LLP partners Jason Fox, Oliver Irwin, Adam Blythe and John Gilbert to talk about the state of the debt and M&A in oil and gas markets.
The general message is that the market for borrowers in the oil & gas sector is good and healthy, with many borrowing options available. Is the borrowing market as “hot” as it was prior to the 2015 financial crisis? Not quite. It’s certainly not as liberal now as it was then.
A new class of UK upstream oil and gas independent companies are emerging, mainly backed by private equity. While private equity backing has a long history in North America, it is relatively recent in the UK, and is currently featuring actively in many deals with backing from the likes of Carlyle and Blackstone groups.
Popularity of reserve based lending as a source of funding
Reserve based lending (RBL), under which loans are made against an oil and gas field or a portfolio of producing oil & gas assets, with the loan amount being based on the value of the borrower’s oil and gas reserves, is still the tool of choice for independents.
Layer upon layer…
RBL is now commonly layered with other classes of debt. Where borrowers are looking to raise large amounts (at the US$ 450 or 500 million level), RBL is being combined with high yield bonds (for example, Neptune Energy who raised a high yield bond in the US market this year).
For smaller borrowings (at the US$ 100 million level), the active market in Norwegian bonds is an option used by many independents, with Faroe Petroleum and Point Resources being such examples this year. Unlike high yield bonds, Norwegian bonds are documentation light, can be put in place quickly and require general, not detailed, disclosure.
Funding from trading houses is gaining prominence. A third to a half of deals have a trading house involvement. Traders are now often willing to offer debt to secure offtake contracts.
Export credit agencies (ECA) which have not been traditionally present in upstream activity, are now appearing in deals. For more information on ECA finance, see Practice note, Export credit agency finance: overview.
The challenges for borrowers
The key challenges currently affecting the borrowing market are:
- Difficulty in raising smaller amounts.
- Weariness from some international banks to lend into projects in sub-Saharan Africa caused by recent defaults in Nigeria and other local jurisdictions.
Buoyant M&A Market
Increased liquidity in the debt market has influenced the M&A market which is currently buoyant. There are many sale opportunities and good levels of deal activity.
Factors and trends influencing the market include:
- Relative oil price stability is encouraging realistic valuations from buyers and sellers.
- M&A acquisitions are used to quickly replenish reserves and address deficit concerns following the suspension and curtailment of many exploration and development projects, following the 2015 price downturn.
- Growing profits and revenues resulting from the increase in oil prices (as well as from general cost cutting across the industry) is providing oil and gas companies with funds to invest in M&A activity.
- Significant buyer demand, with private equity emerging as a new class of buyer in the North Sea. Trading houses, too, are participating not only on the debt side in return for offtake, but in equity as well. Similarly, service providers are providing equity in return for the project development work.
- Good supply of assets caused by the majors’ retrenchment from certain markets. For example, in Nigeria, where the majors have been moving away from onshore oil and gas production, while staying in the deep water offshore developments. Also, in the North Sea, where the majors have been selling to the private equity class of buyers. This is expected to continue, for example, Chevron has recently announced that it is looking to move out of the North Sea.
- Developments in floating LNG technology are supporting an increased attractiveness of gas reserves.
- New jurisdictions coming into the market causing excitement. This includes, Namibia, Senegal and Mauritania, and demonstrates the majors’ (and other international oil companies’) willingness to invest through M&A activity in Africa. Similarly, new significant exploration finds in Egypt and the recent liberalisation in Mexico are also resulting in increased M&A activity in those jurisdictions.
Demand for LNG volumes continue to increase. Since 2000, LNG volumes traded have tripled. 2017 saw the largest annual growth in LNG demand since 2011. Demand is anticipated to grow, but perhaps not at the 2017 levels. A number of projects are expected to reach final investment decision (FID) in the period 2018 to 2020.
The full potential of US Shale and LNG volumes coming into Europe is still to be realised. In 2017, the majority of gas into Europe was pipeline gas from Russia and Norway, with LNG supplies accounting for only 12%.
In North West Europe, traditionally the upstream supplier was the actual producer and the buyer under a long-term contract with a power generator or retail supplier. That structure has been disrupted by a number of factors (including greater availability of LNG volumes) with new players having an increasingly important role in gas markets, such as traders.
For a number of years in North West Europe, there has been a move away from pricing based on oil indexation to hub-based pricing.
There is debate as to whether these changes (among others) are impacting on the length of contracts. Reports suggest that the traditional 20-year contracts are now reducing to the 12, 10 or even 8-year mark.
For many, the focus on disputes has shifted to Asia Pacific, where a growing demand for gas, deregulation and new sources of supply have led many to anticipate a growth in price renegotiations and a push for greater destination flexibility. The nature of disputes is also changing. Traditionally, gas disputes focused almost exclusively on price. More recently, they relate to flexibility. Sellers are looking to reduce volumes supplied or avoid supplying altogether, in order to chase better prices and opportunities elsewhere.
The future is bright
Overall, the outlook for upstream oil and gas borrowing, M&A activity and LNG is good, with market buoyancy and growth expected to continue, certainly in the short to medium term.