Private equity (PE) funds are warming up to the idea of investing in the oil and gas sector, on the prospects of higher oil prices in the future. While the PE funds had enough firepower to invest in 2015, they lacked confidence in the market.
Nevertheless, 25 of the 100 funds who took part in the latest EY survey conveyed that they are keen on a buyout by the end of 2016, and if we increase that time period to a year, the number of PE firms keen on acquisitions in the oil and gas sector rises to 43.
The current oil crisis, which saw prices plunge from three figures to less than $30 per barrel, have led to large-scale bankruptcies in the sector. The banks have tightened their lending norm, post-publication of new strict guidelines by the Office of the Comptroller of the Currency.
The bank squeeze and persistent low oil prices are likely to push the highly leveraged players to the brink of insolvency. The efforts of the oil companies to sell their low-quality assets have, so far, not met with much success.
"There is a valuation gap between the sellers and the buyers right now," says Andy Brogan, global oil and gas transactions leader at EY in London. "With oil prices remaining low, buyers' views on assets are lower than those of the sellers. But we are likely to start seeing some forced sales of assets, or transactions coming in lower than sellers would prefer," reports Euromoney.
The PE firms are awash with liquidity; they have more than $1 trillion in dry powder waiting to be invested in the oil and gas sector, according to the EY survey.
Nonetheless, the PE funds that have invested in the oil sector have faced a bumpy ride so far. Large firms such as KKR, Riverstone, Apollo and EIG Global Energy Partners have all faced losses on their investments in the sector.
"It's true that some private equity firms have experienced losses," says Brogan, "but a lot of that pain was concentrated in funds that were latecomers or that were generalists. They were buying at the top of the cycle in 2012 and 2013," reports Euromoney.
However, with oil prices consistently remaining below $50 per barrel, the scenario seems to be changing. Related: Move Over Oil - Lithium Is The Future Of Transportation
"Greater consensus over the oil price future and more favorable asset valuations are improving the conditions for PE, and we expect to see an uptick in deals before the end of the year," said Brogan, reports the Business Insider.
The next round of pullback in oil prices is around the corner, according to David Bianco and the strategy team at Deutsche Bank.
"The strong oil price bounce from Feb low meets some resistance," said Bianco in a note to clients. "Disruption in Canadian output recedes; U.S. rig count rose for 3 weeks; and no output freeze pact is in sight from OPEC," reports the Business Insider.
If oil retraces the steep rise from the lows, it will usher in a new wave of debt burden on the companies. The companies will be left with no other option than going into deals with the private equity players, who have the cash.
"PE-backed companies are looking to joint ventures to help them cut costs, while others hope contingent pricing will offer much-needed price stability," said Michael Rogers, the Ernst & Young global deputy private-equity leader.
With the oil and gas sector struggling to stay afloat, the PE players with their huge cash reserves are ready to make the most of this opportunity to buy assets at distressed prices.
By Rakesh Upadhyay for Oilprice.com
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Rakesh Upadhyay is a writer for US-based Divergente LLC consulting firm. More