Sizing up value in oil and gas deals

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Viken Chinien Viken Chinien
Head of due diligence, London, DNV GL - Oil & Gas
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Mergers and acquisitions will increase demand for key types of due diligence, financial and technical experts say

Scrutiny of capital and operating expenditures (capex and opex), and liabilities is intensifying as expectations rise that mergers and acquisitions (M&A) in the oil and gas sector will accelerate.

In 2015, 379 M&A deals were recorded; 10 fewer than in 2009 during the depths of the global economic downturn.[1] “Deal numbers are not the whole picture though,” said Jonathan Shelley, the corporate finance partner who leads global advisor PricewaterhouseCoopers’ UK team for M&A transactions in oil and gas and energy services. “The number of contemplated deals in 2015 was actually significant, and a large number are still being worked on.”

Transactions are taking longer due to the challenging environment, he explained. “We expect that will change during 2016, and anticipate more completions. Banks and bondholders were patient in 2015, particularly for upstream. Everyone now recognizes that oil prices will be lower for longer, and there are more challenging situations around balance sheets.”

Potential buyers include companies that are highly or somewhat confident about hitting profit goals. DNV GL research found 28% of these planned to seek M&A targets in 2016. Conversely, 27% of companies that were highly or somewhat pessimistic about achieving their profit targets wanted to increase asset sales and to make divestments.

“When deal activity in the upstream sector inevitably rebounds, it will become clear that it is now a buyer’s market,” said Viken Chinien, head of DNV GL’s due diligence hub in London. Together with a sister hub in Oslo, Norway, this provides technical, commercial, and environmental due diligence for investing in or divesting oil and gas assets. It critically assesses sellers’ capex and opex forecasts in light of the technical condition of the assets, and generates figures for scenarios that buyers wish to see modelled when negotiating price.

Technical questions
Technical due diligence is now even more essential, Shelley observed. “One reason is that with [upstream] valuations down, a USD50 million (m) technical problem in a USD500m deal is a bigger risk than in a USD1 billion deal.”

Another reason is trends in the development of new fields, he suggested. “While it might previously have taken five years to produce a development plan for a new field involving a fixed platform, plans are now being put together more rapidly in response to market conditions. They may instead involve subsea production and floating production, storage and offloading, for example. Some such plans are maybe not as ‘thought through’ as before, so technical due diligence is critical.”

This consideration is equally relevant to a buyer acquiring fields in the planning or early execution phases of development, or to a lender considering whether to finance developments, Chinien noted. Questions of interest include: operational performance of a facility, and how it compares with industry standards; the integrity of the structures and main items of equipment; the status of inspection, repair, and maintenance programmes; and maturity of safety management systems, as well as compliance with safety regulations. All these technical aspects impact directly on capex and opex forecasts.

Examples of commercial due diligence include establishing shippers’ tariffs for oil, gas and other products entering transport and distribution networks; contractual utilization and booking behaviour of shippers; and benchmarking asset performance against similar infrastructure.

“This category of diligence is important amid rapid change, when the rule book on contracting structures is being ripped up,” Shelley said. “You cannot rely on knowledge of historical practices.”

Environment and decommissioning
Environmental liabilities can break a deal. Due diligence advisors check compliance with regulatory permits, emissions performance and potential future influence on operations, as well as historical land and groundwater contamination, and subsequent liabilities.

“This enables an accurate description of the specifications, condition and associated liabilities of assets, and allows appropriate warranties to be drawn up,” Chinien said. “It also allows buyers to avoid purchasing unwanted assets, though there can sometimes be flexibility to negotiate around environmental liabilities through inclusion of risk-sharing in purchase and sale agreements.”

Decommissioning liabilities are the largest issue when calculating discounted cash flow to gauge company valuations, Shelley added. “This has become a significant feature of exploration and production M&A, especially in mature oil and gas provinces,” said Chinien. “Well plugging and abandonment liabilities can be very large, for example.”

Global experience aligned with local involvement

DNV GL has well-established global hubs for due diligence in London and Oslo, and has experts around its worldwide network to provide local involvement in such work for M&A deals and project financing.

“Most new offshore oil and gas projects are in Brazil, Gulf of Mexico and West Africa,” said John Tate, manager for due diligence, Noble Denton marine services, DNV GL - Oil & Gas.

“Key smaller developments are underway globally however, and there is increasing demand for local involvement. This requires on-the-ground experience backed by a global presence and DNV GL is one of few due diligence specialists offering this.”

With expertise in Dubai, Houston, Paris, London, New York, Oslo and Singapore, the company offers technical due diligence advice from Europe and the Americas, and yard attendance from Singapore.

[1] ‘Oil & Gas mergers and acquisitions report – year-end 2015’, Deloitte Center for Energy Solutions, January 2016


DNV GL prides itself on providing accurate information but makes no claims or guarantees about the accuracy, completeness or adequacy of contents in this publication, and disclaims liability for any errors or omissions. The authors’ views here do not necessarily reflect DNV GL’s views.