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Energy: Deals 2022 midyear outlook

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Oil and gas deals poised to accelerate 

Oil and gas deal activity will likely accelerate in the second half of 2022 as buyers gain confidence that high commodity prices will persist. Investors who turned away from the industry in recent years are reassessing their strategies.

Higher prices may curtail corporate deals as companies retain assets. However, private players looking to capitalize on higher prices may boost production with acquisitions as internal drilling programs are hampered by a lack of materials and labor shortages.

Concerns about the US economic outlook and geopolitical unrest slowed deal activity in the first half of 2022. However, year-over-year deal activity remained strong, with a reported 123 deals valued at $107 billion during the last 12 months (LTM) ending on May 15, 2022. This is up from the 98 deals during the previous LTM, a period which had a similar total deal value. Upstream deals accounted for most of the transactions so far this year — a trend that will likely continue in the second half of the year if the Colgate Energy Partners megadeal is any indication. That deal, valued at a reported $508 million, closed just days after the period analyzed for this midyear report.  

Oil and gas is in favor again

Investors’ emphasis on renewable energy has been muted by higher commodity prices, resulting in stronger returns among traditional oil and gas producers. West Texas Intermediate crude, the US benchmark, increased more than 60% this year, and natural gas prices have more than doubled. Some companies have responded to the higher prices by holding on to properties they might otherwise have sold. However, the prospect that the elevated prices will continue, amid sanctions against Russia for its invasion of Ukraine, is triggering renewed interest in traditional oil and gas production.

In the competition for capital, oil and gas has performed well year-to-date. The Standard & Poor’s Exploration and Production Index has increased 76% this year, compared with a 49% decline for the Nasdaq. As a result, many institutional investors are rethinking their strategies. While public companies have continued to focus on shareholder returns and resisted the urge to significantly expand drilling programs, private companies are deploying capital more rapidly.

Demand for natural gas — and, more specifically, liquified natural gas (LNG) — will likely rise as US LNG suppliers step up shipments to Europe to offset the loss of Russian gas. Suppliers may attract increased capital corresponding with more long-term contracts from Europe and Asia as those regions look to secure supplies.

Sub-sector outlook

Investment returns to energy production

Investors remain cautious about oil and gas but the likelihood that sustained prices above $100 a barrel will continue for much of the year may generate more activity. After a year in which ESG concerns and a desire for dividends put a damper on transactions, the market may be returning to a more traditional outlook in which higher commodity prices are indicative of increased deal activity. While onshore oil plays such as the Permian Basin will continue to attract investment, capital also is likely to continue flowing into projects in the Rockies and North Dakota as well.

Natural gas is likely to draw attention in the year ahead as demand from Asia remains strong and European countries looking to replace Russian gas turn to the US for long-term contracts. Most US LNG supplies are owned by joint ventures, making acquisitions more difficult. As a result, we expect more investment deals rather than M&A transactions during the second half of the year. In addition, LNG terminals and infrastructure require large investments totaling billions of dollars that won’t pay out for at least three to five years. Investors may be wary of the uncertainty of such long-term horizons and issues related to expanding capacity too rapidly. 

Oil storage and transport ripe for deals

Demand for pipelines remains strong. Despite an increase in new pipelines built in places such as the Eagle Ford Shale and the Permian Basin, there’s still a shortage of transportation assets to get oil and gas from those regions to refineries. Little to no investment has been directed toward new pipelines on the West Coast and the Northeast. In the Northeast, consumers continue to use more heating oil than natural gas because of a lack of pipelines that would allow homes to be supplied from nearby gas plays such as the Marcellus Shale. 

The big impediment to new investment in midstream is the rising cost of capital and construction. Gaining right-of-way for new pipelines has gotten more difficult, frequently drawing protests from environmental groups that can lead to higher costs and even litigation. Larger pipeline companies may look to acquire smaller players to build out their networks rather than build new lines. 

Search for synergies drives OFS deals

The oilfield service sector continues to face immediate challenges from supply chain disruptions and labor shortages left over from the pandemic. Shortages of materials such as cement and steel, inflation, a lack of drilling equipment relative to demand and labor issues have kept service companies from responding to new drilling demand as commodity prices rise.

The ongoing price uncertainty and geopolitical unrest will put pressure on deals. At the same time, the higher prices could lead to more consolidation among domestic services companies in the second half of the year as providers look for synergies to shore up their offerings and reduce costs. 

Refiners eye higher prices to spur deals

High demand and soaring prices for gasoline and diesel have pushed up refining margins, a trend that is likely to continue at least through the summer. The industry continues to struggle with labor issues, a lack of storage for refined products and chronic underinvestment.

While the downstream sector may draw some new investment in the short term, the long-term deal outlook remains cloudy. Few large companies are willing to make long-term commitments to new refinery assets given the prospect that demand will decline as electric, natural gas and, perhaps, hydrogen-powered vehicles take to the road. However, there may be some deals for specific assets as larger operators look to sell individual refineries to focus on core competencies or divest of refining businesses altogether. 

“Private equity deals are on pace for another record year as traditional oil and gas investments become attractive once again. At the same time, investments in renewables, carbon capture and storage as well as other ‘green’ assets continue to grow. ”

— Seenu Akunuri, Energy, Utilities and Resources Deals, Principal, PwC US

Key deal drivers

Capital discipline

In the US, strong returns from oil and gas companies relative to technology and other sectors this year have attracted new attention from investors. Institutional portfolio managers are reconsidering their earlier decisions to direct capital away from oil and gas in favor of renewables or other ESG strategies.

The energy sector, as a percentage of the S&P 500, remains low historically. Investors are trying to determine how sustainable the returns will be and how disciplined management will remain if prices and cash flows stay at current levels or go higher. While many remain on the sidelines, we believe activity will pick up if returns remain high.

Meanwhile, private companies are stepping up investments in new drilling to take advantage of the commodity price environment.

In Europe, the major producers are recycling capital from traditional oil and gas assets into renewables and green investments, which is likely to continue through the end of the year. 

Navigating uncertainty

Like other sectors, the oil and gas industry faces uncertainty from supply chain disruptions, inflation and labor issues. As discussed above, the oil field services industry is particularly vulnerable.

The higher cost of capital and growing concern about where the economy is headed — and whether the Federal Reserve can tame inflation without triggering a recession — could put a damper on deal activity. Geopolitics also could put the brakes on potential deals during the second half of the year.

In addition, the uncertainty surrounding commodities prices makes it difficult for companies and investors to make decisions. Adding to those concerns is the potential for regulatory reaction to the higher prices, such as capping gasoline prices. Higher prices could lead to easing restrictions for domestic drilling, although it’s not clear how long such policy reversals might last. However, high pump prices could create a consumer backlash, which — especially in a mid-term election year — could lead to policies that make deals less attractive.

Speed to unlocking value

As the focus shifts to building resiliency and greater energy security, investments are likely to pick up across the value chain.

Companies outside of the sector continue to work to reduce their carbon emissions, which could lead to more investment in natural gas infrastructure in particular. Within the industry, the growing regulatory pressure to reduce emissions will lead to increased investment in carbon capture technology for many traditional oil and gas companies. Some companies that traditionally would have been competitors have established joint ventures for sharing and developing carbon capture technology. For example, Chevron recently announced a joint venture with Talos Energy and Carbonvert, while Enterprise Products and Occidental Petroleum reported a joint venture to reduce carbon in oil and gas transportation. These partnerships could encourage future deal activity as participants place different values on the venture, leading some partners to buy out others’ interest. 

Resiliency and security

With the geopolitical turmoil of early 2022, investors have realized that the energy transition will be neither smooth nor easy. Restricting capital for oil and gas infrastructure and activity impacts prices, which contributes to inflation and has a ripple effect across the economy. The focus in the second half of the year is likely to shift toward ensuring more secure energy supplies, which will require more investment in traditional oil and gas development.   

Over the long term, the response is likely to result in a portfolio approach, in which more capital returns to oil and gas production for the short term, but the broader focus will remain on renewables and longer-lead projects such as 20- to 30-year contracts for LNG. 

Global energy needs

Higher commodity prices will have the biggest impact on upstream deals, as investors’ hesitancy about the sustainability of returns subsides. LNG is ripe for additional investment as global demand, particularly from Europe, accelerates. While fewer deals are likely in midstream and downstream sectors, the need for additional infrastructure such as pipeline and storage could drive a modest level of deal activity in the second half of the year.

The combined needs of greater energy security and reduced carbon emissions will drive more cross-sector deals as well. The energy industry is becoming less linear, with oil and gas companies investing in renewables, utilities expanding into new markets and a growing emphasis on ESG forcing all companies to rethink their long-term strategies. This transition is likely to drive additional deal activity across the sector for the rest of 2022 and beyond.  

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Seenu Akunuri

Seenu Akunuri

Energy, Utilities and Resources Deals, Principal, PwC US

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