After two months of an encouraging—if not half-hearted--rebound, oil prices have gone into reverse gear once again. Futures tied to WTI crude were down a whopping 8% on Monday morning to trade at $36.35/barrel, a level they last touched two months ago as the markets come under a fresh wave of pressure from a stalling recovery in demand as well as a mistimed expansion of production by OPEC that threatens to reverse the gains by the cartel’s latest production cuts. The latest rout has elicited another round of price cuts by Saudi Arabia in a situation eerily reminiscent of the oil price war that sent the markets crashing into negative territory for the first time ever.
But as the debt-riddled U.S. shale patch braces for a new reality of ‘Lower Forever’ with massive asset writeoffs amid a growing wave of bankruptcies, its equally distressed neighbor further north has resorted to a different trick: Mergers and Acquisitions.
Starved of vital capital by weary banks and shareholders, small- and mid-sized oil and gas companies in Canada are scrambling to find partners in a bid to become bigger and-- hopefully--more solvent.
Meanwhile, bargain-hunting private equity firms have pounced on the opportunity, hoping to buy distressed assets for pennies on the dollar.
WTI Oil Price 30-Days Change
Source: Business Insider
Source: Visual Capitalist
Orphaned Businesses
After years of continuous underperformance and paltry returns following a six-year downturn by the sector, cheap credit for Canada’s oil and gas companies has dried up, forcing them to look for less conventional means to survive.
The Covid-19 crisis has only served to worsen the situation, with the S&P/TSX Capped Energy--Canada’s equivalent of the U.S.’ Energy Select Sector SPDR Fund (XLE)--down 46.8% in the year-to-date vs. -41.9% return by XLE.
S&P/TSX Capped Energy
Whereas some companies like Bow Energy Ltd. (CVE:ONG) and Cequence Energy Ltd (TSX:CQE) have filed for bankruptcy protection or opted to restructure, many smaller producers such as Obsidian Energy Ltd. (OTCMKTS: OBELF) are putting themselves up for sale.
PE firms like Waterous Energy Fund have turned into trophy hunters, buying up distressed assets at dirt-cheap valuations including last year’s purchase of Pengrowth Energy Corp. for $740-million, representing less than a fifth of its more than $4B valuation at the time of the deal.
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Massive discounts have pretty much become par for the course for Canada’s M&A space: A total of 23 such deals have been consummated in the year-to-date for an underwhelming total of $1.65 billion compared to $15.47 billion deal value from 42 M&A deals completed during last year’s corresponding period.
Waterous is a master of the game, having amalgamated six small producers from different deals into a giant it has dubbed Strathcona Resources Ltd., easily one of North America’s largest private-equity owned drillers with a daily production clip exceeding 60,000 barrels.
According to Waterous CEO Adam Waterous, there has never been a greater need for consolidation in Canada’s energy sector, noting that small oil and gas companies have been locked out of debt and equity markets, effectively leaving them orphaned. Waterous says these orphaned businesses need to come together if they are to survive the onslaught, which he does not see ending any time soon.
That said, it is worth noting that bigger oil companies have been holding up pretty well, with the likes of Suncor Energy Inc. (NYSE:SU), Cenovus Energy Inc. (NYSE:CVE), Canadian Natural Resources Ltd. (NYSE:CNQ) and Husky Energy Inc. (TSE:HSE) having little trouble tapping debt markets.
Dearth of Mergers
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Source: Haynes and Boone
The situation back in the U.S. could not be more different.
Debt-ridden U.S. oil companies have been filing for bankruptcy at an alarming clip while M&A action has been hard to come by.
According to Haynes and Boone Oil Patch Bankruptcy Monitor, 32 U.S. shale companies filed for bankruptcy protection in the January-July period, representing aggregate debt of more than $49B, with nine producers filing in July alone. Haynes and Boone says it expects this pace to continue in the coming months even if oil prices record a substantial rebound.
In contrast, M&A deals have been few and far between, with Chevron Inc.’s (NYSE:CVX) purchase of Noble Energy for $5B and Sunrun Inc.’s (NASDAQ:RUN) $3.2B takeover of Vivint Solar the notable exceptions. In fact, 2020 was shaping up as the slowest year in M&A activity for decades before the two deals were announced.
Big Oil has lately become unusually averse to acquisitions after a string of disastrous deals in recent years left many companies struggling with mountains of debt.
By Alex Kimani for Oilprice.com
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