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THE WALL STREET JOURNAL: ENERGY: Urge to Merge

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THE WALL STREET JOURNAL: ENERGY: Urge to Merge

Why high oil prices may mean more acquisitions this year
By BENOIT FAUCON
February 11, 2008; Page R14

High crude prices appear to be here to stay, at least for the next few years. And that could fuel a wave of mergers and acquisitions in the oil industry.

As crude prices continue to rise steadily — from an average of about $26 a barrel in the U.S. in 2003 to an expected $80 this year, according to Citigroup Inc. — and demand continues to increase, a host of potential buyers of oil assets are looking more closely at possible deals.

Private-equity firms, for instance, see the promise of profitable investments. State-owned oil companies from booming China and India are more willing to make big outlays for the assets they crave. Oil companies from producing countries are flush with cash and looking to expand. The big international companies are adjusting their portfolios to focus on their most profitable assets and to buy the advanced technology they need to keep an edge amid growing competition. And small and midsize oil concerns are more likely to pair up to survive.

Private Interest

The appetite for oil assets among private-equity firms may be the surest sign of a shift in expectations for the industry. Unlike other companies, whose acquisitions are dictated in part by long-term strategic concerns, these firms are motivated solely by the investment value of what they acquire. They wouldn’t be buying if they were concerned about those values falling anytime soon.

Private-equity firms have shown a particular interest in oil-services companies and small refineries. For instance, First Reserve Corp., based in Greenwich, Conn., recently bought oil-services company Abbot Group PLC of the United Kingdom for the equivalent of about $1.8 billion.

The fact that First Reserve topped the bid of another private-equity firm, London-based 3i Group PLC, among others, is a significant sign of private equity’s interest in oil assets. First Reserve has said it is considering further acquisitions in the oil industry.

Thirsty and Hungry

For state oil companies in consuming countries — like China and India, where demand for oil has surged amid rapid economic growth — “there are other considerations than rates of return, such as access to resources and security of supply,” says Alastair Maxwell, managing director in charge of European oil and gas investment banking at Morgan Stanley.

For these companies, “high oil prices make it easier to justify” making expensive acquisitions, he says. With no end in sight to rising prices, it’s better to own the oil than to pay someone else for it.

Interest in acquisitions appears to be percolating at China’s state-owned companies in particular. For example, China National Petroleum Corp., the country’s largest oil company by assets, is bidding for stakes in four production and exploration blocks in western Africa owned by Devon Energy Corp. of Oklahoma City, Okla. Cnooc Ltd., another Chinese state company, has looked into stakes in several blocks in Nigeria owned by the Anglo-Dutch Royal Dutch Shell PLC.

In contrast to state companies from countries thirsty for oil, companies from crude-producing countries don’t have an immediate need for new oil resources.
 
But Persian Gulf governments, which have plenty of cash after three years of soaring oil revenues, have been spending billions abroad in a bid to diversify their investment portfolios and to gain further access to advanced technology and know-how. And they plan to keep spending. For instance, last year, government-controlled Abu Dhabi National Energy Co. announced about $7.5 billion of acquisitions in Canada as part of a goal to invest $60 billion world-wide by 2012.

Big Sellers and Buyers

State oil companies and private-equity firms often find willing sellers in the major international oil companies. For instance, in August, Royal Dutch Shell agreed to sell three small French refineries to two private-equity-backed ventures, Dutch petrochemical group Basell International Holdings BV and Swiss refiner Petroplus Holdings AG.

The reason? Contrary to conventional wisdom, surging crude prices have become a threat to Big Oil’s profits. The oil majors’ production-sharing contracts with the governments of the countries they drill in often call for the government to get a bigger share of output when the price of oil rises. So the oil companies don’t fully capture the increase in prices. In some cases, governments have pressured oil companies into renegotiating contracts or giving up control of projects, all of which eats into the companies’ profits. Meanwhile, skyrocketing oil prices encourage more exploration and drilling world-wide, which leads to inflation in the prices of oil services. “In some projects in the Middle East, cost inflation is reaching over 40%,” says John Martin, a managing director for European commodities business at Standard Chartered Bank PLC.

As a result, the big oil companies are looking to divest noncore, less-profitable assets to focus on their most profitable projects.

Surging oil prices could also influence the oil majors’ acquisition strategies. By emboldening state-owned companies to expand internationally, the higher oil prices indirectly encourage the oil majors to buy assets that can help them maintain a competitive edge.

Large oil companies are putting more emphasis on advanced technologies — the ability to explore in Arctic regions or in very deep water, for instance — than in the past, and that will be “a key driver” in their acquisition plans, says Mr. Martin. For example, he says, Shell’s purchase of full control of its Canadian subsidiary last year was driven in part by the need to take full ownership of a key technology it wanted to transfer elsewhere.

Small Targets

While cost inflation is crimping the big companies’ profits, it is weighing the heaviest on smaller independent companies. This is happening at the same time that the general tightening of global credit markets may make it harder for smaller companies to find financing, says Frank Kuijlaars, global head of oil and gas at ABN Amro Bank NV. Together, those factors are raising expectations for a round of consolidation in this sector of the industry.

Alec Carstairs, head of Ernst & Young’s mergers-and-acquisitions team in Scotland, said in a recent report that the “consolidation trend is set to hit an all-time high in the U.K.-listed oil and gas sector.” There has been some consolidation in this sector in recent months. In August, U.K. North Sea explorer Venture Production PLC reached agreement on the acquisition of smaller peer Wham Energy PLC for £14 million ($27.7 million). In November, Cairn Energy PLC acquired Mediterranean specialist MedOil and Plectrum Petroleum PLC, which has assets in Peru, Tunisia and other countries, for a combined £38 million.

Every small and midsize company in the sector is a potential target this year, said Mr. Carstairs, with the number of such companies listed on the London Alternative Investment Market expected to decrease by as much as one-third from the current 117.

–Mr. Faucon is a reporter for Dow Jones Newswires in London.

Write to Benoit Faucon at [email protected]

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One Comment

  1. Brad Marcus says:

    We believe this trend will continue and is why we are hosting an Executive Forum on Deal Making in the Energy Sector.
    For more information
    :http://www.execforum.net/events/eventimages/06.25.08/main.html .
    I can be reached at [email protected]