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May see revival of M&A activity
July, 27th 2009

A global economic revival may still be some way off, but analysts see another kind of revival in the oil and gas sector. The recent $7.2-billion Sinopec takeover bid for Alberta-based Addax Petroleum has raised hopes of a resurgence in the merger and acquisition activity in this industry.

Though the oil and gas sector seldom sees takeovers, like those witnessed in the steel sector before the global slowdown kicked in, industry players see resumption of activities like acquisition of oil and gas blocks, and takeovers of small exploration and production companies and oil industry service providers. This is despite the fact that the refinery business continues to be a laggard, with profitability still low in the segment.

The financial crisis that began last year has had a wider impact beyond deciding investment in marginal oil and gas projects, which are considered lucrative when prices move above $100 a barrel. It has created a compelling dynamic for a resurgence in merger and acquisitions, with plenty of assets for sale for those with finance, said Carl D Hughes, energy and resources leader, Deloitte UK.

The days of the banking sector throwing money at anything associated with oil and gas are behind, but Hughes adds that as the year progresses, funds would flow back to selected companies and projects and there would be mergers and acquisitions across the board. He sees private equity and sovereign wealth funds being attracted by investment opportunities in upstream and downstream ventures alike.

KPMG executive director Jai Mavani agreed liquidity had improved globally and availability of assets at reasonably low value would make these attractive once recovery kicked in.

Crude oil prices, now moving in the range of $60-65 a barrel after diving to $38 a barrel in February this year, have restored confidence in investors. Oil prices had gone down too low but they have showed improvement, with the prediction being that even if they fall now they will not fall drastically. So, some acquisitions have happened but mergers in the oil sector happen only once in a while, said R S Butola, managing director, ONGC Videsh Ltd, the countrys biggest acquirer of overseas oil assets.

OVL acquired Imperial Energy for around $1.9 billion just before the slowdown kicked in. Since then, it has acquired exploration properties in Colombia and Kazakhstan, and put in a bid for blocks in Iraq. It is also eying Kosmos stake in the Jubilee oilfield in Ghana.

Besides India, oil and gas exploration blocks are on offer in Egypt, Indonesia and Algeria, while some producing properties are on sale in Africa. On what prompted these countries to put blocks on offer when there was a global slowdown, Butola said, By the time recovery happens, the rounds will get over. He agreed that liquidity had improved, but added that the real economy had not revived, as demand was not picking up.

Distressed smaller players, short of operational cash flow and working capital, will be attractive targets for companies that want to increase reserves at depressed prices and complete development projects that are viable but for availability of funds, said Hughes.

Reliance Industries Ltd president (international business) Atul Chandra is, however, sceptical about the revival and attributes the optimism to consultants eager to close deals. There is only a partial revival, since people believe oil prices are high. The rise is more out of speculation than a real boost in demand. Things will continue like this till the year-end when prices will dip again, since demand will fall further.

Chandra said good projects had still not come into the market. RIL has been scouting for investment opportunities abroad, but Chandra feels most players are not in a hurry to acquire oil properties, especially exploration blocks. Cash flow of most companies is low and they are not sure how the situation will unfold. But the issue is not so much about liquidity as it is about confidence in the economy, he said.

Besides exploration, the oil service sector has seen mergers. It is important to have a good backbone in exploration and production business so buyout of controlling stake in companies offering support services, rig fabrication and geological services at a good valuation will take place, Mavani said.

Though Mavani said exploration companies should also look at taking over service companies, Butola said oil companies would not do so and service companies would merge among themselves.

In contrast is the state of the refining sector, where no big mergers are expected. According to Mavani, there are two reasons for this. One, there is overcapacity in refining in some regions, including India. Therefore, it does not make any sense to acquire refineries when the demand for petroleum products is not picking up. Also, the refinery business is geography sensitive and linked to demand centres. Chandra agreed refineries were operating at less capacity and low margins.

However, oil sector acquisitions are expected to precede overall global economic revival, with buyers eager to take over before things become unaffordable again.

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