Despite the obvious pain in the energy sector for the last 18 months, major asset sales have been few and far between in the sector. The problem has been a classic one in markets – sticky prices leading to a wide gap between supply and demand in assets.
Oil companies looking to shed assets either to become more efficient or because of financial distress have been holding out for higher prices under the expectation that oil prices would bounce back soon, creating significant option value in underwater assets. Buyers like private equity firms have been considerably less sanguine though, and have essentially only been willing to pay fire sale prices for most assets.
This gap in expectations has hindered asset sales from companies like Chesapeake, Quick Silver Resources, Swift Energy, Magnum Hunter, and others. Even in bankruptcy, many firms have found out that their assets are worth less than the debt on those properties. This has led to banks like JPMorgan and Citi holding the bag on assets that have values far less than what the banks had lent to the bankrupt firm.
Those banks are motived sellers and will likely keep the market for energy assets depressed for at least a year. Of course for investors with a long-term time horizon like Blackstone or KKR, this could create a major opportunity. Yet private equity firms are being very disciplined with their capital and are only slowly starting to enter the market for such assets.
2016 could be the year that this reticence on the part of buyers starts to ebb though, as sellers may be forced by bankruptcy conditions to relent and accept whatever price they can achieve. Wood Mackenzie recently put out a report suggesting that M&A activity in the oil patch will ramp significantly this year regardless of what happens to oil prices.
Of course, predictions of such consolidation were made with much fanfare last year, but came to little. The problem is that M&A in these situations can only happen when selling firms give up all hope and accept the fact that they must find a buyer at essentially any price. In present circumstances, buyers have all of the power and sellers have none.
There are presently more than $200 billion worth of oil and natural gas assets for sale around the globe as virtually all distressed energy companies are looking at selling assets. In this environment, that comes to about one out of every eight junk-rated companies.
For investors this spells trouble. Even if oil prices do rise again, for many companies the damage is irreversible. A company that sold its best assets during the crisis for a fraction of their pre-downturn value can never recover even if oil prices do. That reality has led firms to hold out as long as they can, but faced with a choice between bankruptcy and selling their best assets, companies will always choose to sell their best assets. In either scenario, equity investors have little hope of recovering much value though.
In this environment, equity investors need to respond rapidly and cut losses in firms that show serious signs of financial stress. To capitalize on distressed asset prices, investors should also look at alternative asset managers and owners like KKR, Apollo (APO), and Blackstone (BX). Just as these private equity firms benefited handsomely from buying housing during the Financial Crisis of 2008, they will likely be the long-term winners from the current Oil Price Crisis. The current market turmoil has provided a good entry point for investors in many of these firms, and energy investors would be wise to take advantage of it.
By Michael McDonald Of Oilprice.com
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