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Conditions ripe for a reshuffle of energy sector pack

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By Lina Saigol and Ed Crooks

Published: January 6 2009 02:00 | Last updated: January 6 2009 02:00

Leading international oil and gas companies could emerge as winners from the financial crisis, as the steep drop in oil prices and asset valuations creates opportunities for mergers and acquisitions.

The big oil groups generally have strong balance sheets and are still able to raise debt finance, while crumbling equity and commodity prices have made many smaller oil and gas companies potential targets.

William Vereker, co-head of investment banking at Nomura, said the strategic rationale for consolidation in the oil and gas sector was compelling. “In 2009 we expect the pressure of falling prices and declining earnings will create the right conditions for mega-mergers as companies look to take costs out through synergies and rationalisation,” he said.

The five largest international oil companies have a total of $82bn in cash, while independents have around $10bn and private companies have $15bn-$30bn that could potentially be spent on acquisitions, according to Deloitte, the professional services group.

Rajeev Chopra, Deloitte’s head of energy in corporate finance, said valuations were becoming more realistic, as management teams of potential targets accepted that the price of oil was likely to stay low. The big western oil groups have struggled in recent years to raise their production and add to their reserves. Acquisitions appear to be an increasingly attractive source of growth if deals can be done at reasonable prices.

Many smaller exploration and production companies have been struggling to raise cash

Oilexco, for example, a Canadian-based independent that was the most active explorer in the North Sea in recent years, has been given until the end of the month to secure further financing. It has attracted considerable interest from companies interested in possible deals, but they seem more likely to pick up Oilexco’s assets than to acquire it outright.

Fox-Davies Capital, the specialist oil and gas broker, says companies with more than 100m barrels of oil equivalent of commercial or near-commercial resources are the most likely acquisition targets. It cites JKX Oil and Gas, Regal Petroleum and Cadogan Petroleum, all of which are developing resources in Ukraine, as potential candidates.

Other companies likely to be attractive are ones with relatively straightforward asset portfolios in resource-rich areas such as Russia or west Africa. Imperial Energy, a London-listed company with Russian assets, was bought for £1.4bn ($2bn) by ONGC Videsh of India last week. Urals Energy, another company operating in Russia, is in talks about a possible takeover, rumoured to be with Sinopec, China’s second-biggest listed oil company.

As for the buyers, mid-sized independent companies are likely to be the most active bidders, according to Mr Chopra, followed by the national oil companies, with the big international oil companies at the bottom of the list.

A “mega-merger”, between BP and Royal Dutch Shell, for example, would be a phenomenally complex transaction, creating a company with almost 200,000 employees and rousing huge political and antitrust concerns.

The big companies seem more likely to go for acquisitions to fill in gaps in their portfolios, as in the recent deals by BP and StatoilHydro to buy US gas assets from Chesapeake Energy.

That has been the model for Eni of Italy, the most active of the majors recently, which picked up Burren Energy in 2007 and First Calgary Petroleums in 2008.

In spite of all the arguments pushing companies towards consolidation, however, there are barriers to deals that will need to be overcome. Although the oil price has stabilised, renewed volatility would create fresh uncertainty about valuations. Some potential targets, such as BG Group of the UK, still look expensive.

Financing deals could also be a problem; even the biggest companies will be looking hard at their cash position if oil stays below $50 a barrel.

Tim Chapman, head of international oil and gas at RBC Capital Markets, said: “International oil companies need a great strategic fit to persuade them that a deal is the right thing to spend their money on,” he said.

In what is likely to be a generally depressed outlook for M&A activity, the oil and gas industry can be expected to be one of the more active sectors.

If low oil prices persist, tightening the pressure on the industry, even the most difficult mega-mergers will be back on the agenda.

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