A prolonged period of low oil prices could lead to further merger and acquisition activity in the sector, Fitch Ratings says.
In a new report, the rating agency suggests that low prices for an extended period could drive M&A activity among energy firms. Smaller, potentially distressed companies are likely to be takeover targets for larger players, it says.
“Smaller companies are typically more vulnerable to low oil prices due to higher leverage, higher production costs and poorer access to external funds,” it says. Additionally, the report notes that some smaller firms “may find it increasingly difficult to finance their big exploration and development programs through bank loans and bond issues in the current environment.”
Fitch says that credit quality at smaller companies could “significantly deteriorate” if oil prices remain below US$60 per barrel. “This could make such companies attractive targets for larger ones with better access to funding and technology, and which have been struggling to increase their reserve base for several years,” it says.
The list of buyers in this scenario could include national oil companies with deep pockets, such as Thailand’s PTT Public Co. and Malaysia’s Petronas, Fitch says; although it notes that they would likely target medium-sized producers, rather than small, distressed companies, “as healthy balance sheets remain a priority for many of them.” The list of suitors would likely include private equity firms too, it notes.
At the same time, Fitch says that lower oil prices pose a hurdle to M&A among major oil companies because it limits their ability to sell assets, and these firms “have been increasingly reliant on disposals to finance growth or reduce their debt burden in recent years.”
“This strategy would probably need to be reconsidered if oil prices remain depressed because asset valuations would fall and buyers have generally been small- or medium-sized companies building local production portfolios. These companies would find it harder to attract finance to support such deals,” it says.
Indeed, the report notes that a combination of lower operating cash flows, fewer disposals, and some potential acquisitions could put the major oil companies’ credit metrics under pressure. “The impact would depend on how they respond, as some might choose to cut capex and exploration expenses, while others might decide to operate with higher leverage, which could lead to downgrades,” it says; although, it says that these changes are unlikely if oil prices quickly rebound to above US$80, as happened in 2009.
Fitch says that it sees $80 as a long-term price equilibrium for oil. “A recovery is likely in [the second half of 2015] but it is impossible to be certain of its timing,” it says. “A lengthy slump would put pressure on many companies, potentially making them attractive targets; a sharper recovery will reduce the need and opportunity for M&A.”