So crude oil prices taking another leg down means it must be time for stoic investors to finally cut their losses and move on to another sector, right?
Not necessarily, according to Citigroup analyst Michael Alsford, who has made a case for a number of mergers that could help oil executives avoid some of the sector’s challenges.
Deals involving London-listed firms like Premier Oil (LON:PMO), Genel Energy (LON:GENL) and SOCO (LON:SIA) could deliver between 5% and 15% of extra cash-flow, he says in a note.
Speculators had better wait just a moment before getting carried away, however, as Alsford’s suggestion is that this new mergers & acquisitions (M&A) activity in the sector would come in the form of ‘nil-premium’ mergers rather than bumper stock market paydays.
Such deals would quite purely be the combination of companies.
Mergers should allow oil bosses to unlock more ‘synergies’ (cost cutting) and additional economies of scale, the analyst explains.
Consolidation would, though, boost liquidity in the stock market and as a result could potentially help normalise squeezed market valuations.
Whilst M&A has been widely anticipated as a result of the downturn - which, in theory, has reduced assets prices - deals have actually been few and far between.
Alsford believes a nil-premium approach could prove to be one way for deals to proceed, and he suggests the rise of shareholder activism could also be a trigger.
“Nil-premium mergers could be a way to navigate the current wide bid-offer spread between buyers and sellers, which we think has been an impediment to E&P [exploration & production] deal activity since we entered the downturn,” the analyst said.
Put to one side Shell and BG’s high profile merger and Alsford believe oil majors will continue to cut costs internally, as they will sacrifice growth to preserve dividends in the short-term.
A broader sector-wide consolidation may not come until later in the cycle, he reckons.
“That said, we still think E&Ps with strategic assets warrant a premium valuation relative to peers.”
Alsford, playing stock market matchmaker, suggests a number of potentially viable combinations.
He says Ophir Energy (LON:OPHR) and Soco International (LON:SIA) would have significant overlap given their similar geographical footprints. He says the former’s funding for near-term development assets could be helped by the latter’s strong balance sheet and production in Vietnam.
The analyst does, though, point to ‘strong personalities’ being present in both management teams, and he says they may not entertain a merger.
Alsford similarly says Premier Oil (LON:PMO) and EnQuest (LON:ENQ) would have ‘significant synergies’ given their operational overlap in the North Sea and Asia.
A combined group would also benefit from diversification, which would mean less reliance on individual assets and mitigate the impact of any delays, he added.
A possible weakness could again come down to ‘strong management teams’ and ‘arguably different company cultures’, according to Alsford who also says corporate activities could be a distraction from what are critical periods operationally.
Kurdistan-focused Genel Energy could combine with Toronto-listed Oryx Petroleum (TSE:OXC), he reckons.
He says Oryx has a ‘stretched’ funding position and smaller market capitalisation, but also has a significant resource base and a key near-term catalyst as it brings online the Demir Dagh field, which is also in the semi-autonomous region.
“A combination of these names would incorporate Oryx’s significant 2P reserve base (271mln barrels) within Genel’s wider portfolio (429mln barrels) at a potentially attractive valuation, adding value through the combination’s reduced funding uncertainty and stronger balance sheet position.
“It would also offer Oryx shareholders access to a more mature diversified portfolio in a company with higher trading liquidity.”
Alsford does, however, point out that the companies have little overlap in terms of existing shareholders and both have large insider positions, which could be an obstacle.
Finally, the analyst also suggests that while geographically different, Lundin Petroleum and Africa Oil could make a match, given that the Lundin family has significant stakes in both.
“While some Lundin Petroleum shareholders might not like the increased political risk of Africa Oil’s Kenyan assets, we believe a share merger would offer an attractive entry point into low-cost development assets.
“Africa OiI’s shareholders would gain access to a lower cost of funding and more diversified asset base.”
The analyst’s report is, naturally, hypothetical though even a cursory reading suggests there might yet be some life in the somewhat downtrodden E&P sector.