A rumoured private equity deal out of the blue this week raises a loaded question, what is the best way to own petroleum assets in the soaring twenties?
At a time when oil prices lurk near all-time highs and there’s scarcely been greater scrutiny on the likes of Shell and BP PLC (LSE:BP.) (oil spills notwithstanding), perhaps there’s a more comfortable way for capital to back oil and gas businesses.
American private equity investor EIG Global Energy Partners kicked off early-stage talks with Spanish major Repsol after an unsolicited approach, according to reports which claimed a deal for 25% of Repsol’s upstream business could be struck.
Repsol with a brief response described its exploration and production business as strategic, but, said whilst no decisions have yet been made the company is analysing various opportunities and proposals.
EIG’s approach is described by analysts as an unexpected move though multiple experts in the sector reckon a new wave of private equity transactions could emerge – or, at least, that market conditions are such that private money seek out what are lucrative assets at attractive public valuations.
Net zero riddle obscures traditional value
The likes of BP and Shell believe the ‘net zero’ concept will give them a future in which new investments in renewables can ‘offset’ increasingly unpalatable petroleum businesses.
With a pinch of optimism, the companies formerly known as oil supermajors pitch the notion that they can lead a multi-decade transition into renewable power from hydrocarbons, funded by the proceeds of ongoing sales of premium-priced hydrocarbons.
All at once, the concept is taken subjectively as either entirely complimentary and virtuously circular or an ethically impossible, conflicted and contradictory.
Shareholders of the energy firms seem satisfied with sweetened returns though bumper dividends and share buyback programmes.
Ecologists and activists naturally have a more linear view. They largely reject the ‘net zero’ thesis, instead insisting on a zero-tolerance view that demands hydrocarbons businesses are wound down as soon as possible.
If such scrutiny wasn’t enough, the likes of BP and Shell are stuck politically between a rock and hard place.
On one hand cast as the public symbols of an industry that must help protect domestic energy security, in the wake of Russia’s war in Ukraine, but at the same time castigated and portrayed among the greedy protagonists in the ‘cost of living’ crisis.
They must develop and deliver new resources to help wean Britain and Europe off Russian imports, but, they also catch flack for bringing brand new fields into play.
Controversy caught fire in recent weeks, for example, as Shell’s Jackdaw project was finally greenlighted. Setting aside the ESG of it all, the field promises to add the equivalent of 6.5% of the UK’s current gas output, easing some of the financial and logistical burdens of importing gas.
In London, at the same time, Shell and BP simultaneously must impress and reward its public shareholder base, but, also avoid flagrant or tone-deaf displays of wealth whilst UK household;s are hit by soaring fuel costs.
Then there’s the AGM stunts. Being a listed company means public shareholder meetings which, as happened last week, can be besieged by mischief makers.
Perhaps it would just be easier to run an oil company more privately.
New deal flow
Private equity fund managers aren’t strangers to the oil and gas industry, albeit recent big investments have been more infrastructure and services based. In the past, E&P deals were often confined to narrower plays and special situations – taking on and flipping North Sea fields, for example, or, speculating in America’s shale boom is another.
The Repsol deal, if it emerges, could be something different.
Reuters reports that the parties are merely in ‘early discussions’ and cited “three sources with knowledge of the matter”, though both Repsol and EIG declined to comment for the news agency’s article.
It was said in the Reuters write up that proceeds from the possible divestment would help fund Repsol’s goal of ‘more than doubling’ its low-carbon power capacity (it is targeting some 7.5 gigawatts by 2025)
In terms of oil and gas, the Spanish firm produces close to 600,000 barrels of oil equivalent per day across a portfolio of assets spanning North America, Bolivia, Colombia, Venezuela, Trinidad and Tobago, Brazil and Libya. Its production base skews towards gas (it accounts for about 70%)
More deals may follow
“Several of the European Oil & Gas Majors have made it clear that they are willing to realise value from their upstream portfolios to reinvest in a greener investment profile,” said David Mirzai, analyst at SP Angel.
“I don’t think its necessarily a new wave, more a continuation of what we’ve seen the last few years with private equity buying into the oil & gas sector as they believe the assets are incorrectly priced for this stage in the investment cycle.”
Mirzai added: “As BP’s Bernard Looney unwisely put it, the oil & gas sector is acting like a cash machine and finally paying out after several years of single-digit capital returns
“The oil & gas sector has also been pretty disciplined in not boosting oil & gas capex to date, and has used its free cash flow in the last year to deleverage rather than return to historical capex levels
“If this discipline is maintained then the free cash flow profile will continue to attract investment from funding sources such as private equity that are less concerned about being seen to invest in more carbon-intensive sectors.”
Discussing more specifically the prospects of a Repsol deal, in a note, Jefferies analyst Giacomo Romeo commented: “The divestment of a minority stake in the upstream business hasn't been discussed before. However, this is consistent with Repsol's other attempts to crystallize value of its divisions by seeking external partners either via IPO or outright sales.
“So far other processes haven't reached a conclusion due to a high valuation expectations by Repsol (commercial business) or challenging market conditions (renewables business).
“An upstream business divestment could find more fertile grounds due to supportive commodity price environment and a wider differential between public and private markets valuation for oil & gas assets.”