More varied and creative deal structures will drive M&A in the oil and gas sector in 2015, and, some lawyers say, activity in the sector will increase compared to an already active previous year.
“The biggest thing I think we’re looking at is this open window for creative structuring of transactions,” says Patrick Maguire, a lawyer at Bennett Jones LLP. “There’s room for a whole bunch of creativity as to how people structure the marrying up of oil companies with more opportunities than they can fund that [works for potential investors anticipating an eventual price turnaround], and investors with that sort of risk profile looking for that three-to-five-year window will find a number of great buying opportunities in this season.”
With rocky oil prices, virtually all oil companies are looking to scale back and re-evaluate their strategies. On Jan. 13, Sound Oil plc withdrew its Nov. 24, 2014 offer for Antrim Energy due to the price environment. Others, including junior oil company Southern Pacific Resources, have been under restructuring processes to relieve debt. In Southern Pacific’s case, it announced on Dec. 30, 2014 that it elected not to make its convertible debenture interest payment. And in other cases capital budgets are being slashed, as is the case for Suncor Energy and Canadian Natural Resources Ltd., as each cut $1 billion and $2.4 billion respectively.
These are tough times for the oil and gas sector. But when the going gets tough, as some lawyers argue, some of the most innovative ideas emerge.
“These times force new and different thinking,” says Chip Johnston, a lawyer at Stikeman Elliott LLP. “If you can extend this until the end of the year, until 2016, that’s an incredible crucible from which to create really interesting, tough management teams...that kind of pricing environment really turns up the pressure on people to come up with new ideas.”
In 2009, for example, Pengrowth Energy Corp. created a royalty structure which allowed it to finance its operations by selling its future production. In its annual information form for the year ended December 31, 2009, it stated that it created Gross Overriding Royalties (GORR) on several properties to sell.
“One technique...in order to finance your company so that it lives another day, is create a royalty, and you can sell that royalty to a company like PrairieSky or Freehold and the market is prepared to pay for a royalty than it is for production per barrel,” says John Cuthbertson, a lawyer at Burnet, Duckworth & Palmer LLP. Alicia Quesnel, a lawyer at the same firm in Calgary, adds that a number of companies created these types of “manufactured royalties” in around late 2009 and 2010, presumably to curb the price environment.
Other deal structures that include third parties taking up operating costs in anticipation of a pricing turnaround may also emerge.
“I think you’re going to see more drilling-fund-type activity [with] large-scale farm-out and joint ventures, where you’ll have people – who have a three-to-six-year window then an expectation that that’s the window for a pricing turnaround – come in and say, ‘listen, I will carry a bunch of your capital costs and drill up, and by the time prices turnaround, everybody’s in a much better shape because we got a bunch of production coming on stream,'” Maguire says.
Maguire also sees a variation on the royalty-type structure as companies look to avoid taking on new debt and avoid diluting their existing shares by issuing new ones. It will be “a good opportunity for entities that have particularly mature production and want to divert restricted capital to some other play,” he says.
In this kind of pricing environment, where prices are low and some highly levered companies aren’t in a position to negotiate, plans of arrangement are often the structure of choice, according to Cuthbertson.
“In Alberta, plans of arrangement are fairly common where deals can be done on a more or less consensual basis, as opposed to a takeover bid, and the plans of arrangement people like it because there’s better protections for both parties in there,” says Cuthbertson. “So that activity will happen.”
On the other hand, Craig Hoskins, a lawyer at Norton Rose Fulbright Canada LLP, says there may actually be an increase in hostile activity where the target isn’t one in financial distress.
“It’s possible you may see – proportionally among acquisitions that do proceed – a little bit more hostile activity, just because situations where the target feels that the offer is opportunistic and they feel that the status quo for them in terms of weathering the storm on the oil prices is preferable, especially for companies that aren’t in as dire straits financially.”
Some lawyers say this is an advantageous environment for the big, liquid, well-capitalized companies with relatively healthy balance sheets, that have rationalized capital, and that have been eyeing particular oil assets for some time, adding this year will see increased and varied M&A activity in the sector.
“I think in really hard times, the number of stakeholders can increase,” Johnston says. “The advantage is, the pressure to do something is real, and it’s difficult, for management of folks that have to do something, to extend and pretend – they end up having to do a deal.”
Beyond the border, Hoskins says his firm has seen a marginal increase in interest from international players.
“In the last couple of weeks, we’ve seen interest from international players, especially large financial players...whether they’re sovereign-type funds or...insurance companies,” Hoskins says. “The interesting thing about a low oil price environment is that a lot of businesses actually thrive and are going to be more successful in that kind of environment, and those that generate cash and look to invest it are turning to the oil and gas sector as an opportunity to maybe do some deals at good prices.”
Though some agree that M&A will increase in the sector in 2015 – based on factors including lower prices for perceived undervalued assets, a need by boards of levered companies to make a move or lose position on deal negotiations, or the lower Canadian dollar that attracts international interest – certainty even at the bottom of the cycle will be preferable over the current volatile price environment.
“I think there are two scenarios: oscillation, which will be less positive for M&A [and] I think relative stability, even at a low price, [which] is more positive for change in the industry,” Johnston says.
“This is an enormously dynamic, innovative and creative business, and the people in this town who do this stuff will invent the next idea to be profitable and successful in the environment,” Johnston says. “This is just a great opportunity to focus people on solving those problems and coming up with the right management, HR, service ideas to create the next generation of growth.
“In some ways, this is a gift.”
“The biggest thing I think we’re looking at is this open window for creative structuring of transactions,” says Patrick Maguire, a lawyer at Bennett Jones LLP. “There’s room for a whole bunch of creativity as to how people structure the marrying up of oil companies with more opportunities than they can fund that [works for potential investors anticipating an eventual price turnaround], and investors with that sort of risk profile looking for that three-to-five-year window will find a number of great buying opportunities in this season.”
With rocky oil prices, virtually all oil companies are looking to scale back and re-evaluate their strategies. On Jan. 13, Sound Oil plc withdrew its Nov. 24, 2014 offer for Antrim Energy due to the price environment. Others, including junior oil company Southern Pacific Resources, have been under restructuring processes to relieve debt. In Southern Pacific’s case, it announced on Dec. 30, 2014 that it elected not to make its convertible debenture interest payment. And in other cases capital budgets are being slashed, as is the case for Suncor Energy and Canadian Natural Resources Ltd., as each cut $1 billion and $2.4 billion respectively.
These are tough times for the oil and gas sector. But when the going gets tough, as some lawyers argue, some of the most innovative ideas emerge.
“These times force new and different thinking,” says Chip Johnston, a lawyer at Stikeman Elliott LLP. “If you can extend this until the end of the year, until 2016, that’s an incredible crucible from which to create really interesting, tough management teams...that kind of pricing environment really turns up the pressure on people to come up with new ideas.”
In 2009, for example, Pengrowth Energy Corp. created a royalty structure which allowed it to finance its operations by selling its future production. In its annual information form for the year ended December 31, 2009, it stated that it created Gross Overriding Royalties (GORR) on several properties to sell.
“One technique...in order to finance your company so that it lives another day, is create a royalty, and you can sell that royalty to a company like PrairieSky or Freehold and the market is prepared to pay for a royalty than it is for production per barrel,” says John Cuthbertson, a lawyer at Burnet, Duckworth & Palmer LLP. Alicia Quesnel, a lawyer at the same firm in Calgary, adds that a number of companies created these types of “manufactured royalties” in around late 2009 and 2010, presumably to curb the price environment.
Other deal structures that include third parties taking up operating costs in anticipation of a pricing turnaround may also emerge.
“I think you’re going to see more drilling-fund-type activity [with] large-scale farm-out and joint ventures, where you’ll have people – who have a three-to-six-year window then an expectation that that’s the window for a pricing turnaround – come in and say, ‘listen, I will carry a bunch of your capital costs and drill up, and by the time prices turnaround, everybody’s in a much better shape because we got a bunch of production coming on stream,'” Maguire says.
Maguire also sees a variation on the royalty-type structure as companies look to avoid taking on new debt and avoid diluting their existing shares by issuing new ones. It will be “a good opportunity for entities that have particularly mature production and want to divert restricted capital to some other play,” he says.
In this kind of pricing environment, where prices are low and some highly levered companies aren’t in a position to negotiate, plans of arrangement are often the structure of choice, according to Cuthbertson.
“In Alberta, plans of arrangement are fairly common where deals can be done on a more or less consensual basis, as opposed to a takeover bid, and the plans of arrangement people like it because there’s better protections for both parties in there,” says Cuthbertson. “So that activity will happen.”
On the other hand, Craig Hoskins, a lawyer at Norton Rose Fulbright Canada LLP, says there may actually be an increase in hostile activity where the target isn’t one in financial distress.
“It’s possible you may see – proportionally among acquisitions that do proceed – a little bit more hostile activity, just because situations where the target feels that the offer is opportunistic and they feel that the status quo for them in terms of weathering the storm on the oil prices is preferable, especially for companies that aren’t in as dire straits financially.”
Some lawyers say this is an advantageous environment for the big, liquid, well-capitalized companies with relatively healthy balance sheets, that have rationalized capital, and that have been eyeing particular oil assets for some time, adding this year will see increased and varied M&A activity in the sector.
“I think in really hard times, the number of stakeholders can increase,” Johnston says. “The advantage is, the pressure to do something is real, and it’s difficult, for management of folks that have to do something, to extend and pretend – they end up having to do a deal.”
Beyond the border, Hoskins says his firm has seen a marginal increase in interest from international players.
“In the last couple of weeks, we’ve seen interest from international players, especially large financial players...whether they’re sovereign-type funds or...insurance companies,” Hoskins says. “The interesting thing about a low oil price environment is that a lot of businesses actually thrive and are going to be more successful in that kind of environment, and those that generate cash and look to invest it are turning to the oil and gas sector as an opportunity to maybe do some deals at good prices.”
Though some agree that M&A will increase in the sector in 2015 – based on factors including lower prices for perceived undervalued assets, a need by boards of levered companies to make a move or lose position on deal negotiations, or the lower Canadian dollar that attracts international interest – certainty even at the bottom of the cycle will be preferable over the current volatile price environment.
“I think there are two scenarios: oscillation, which will be less positive for M&A [and] I think relative stability, even at a low price, [which] is more positive for change in the industry,” Johnston says.
“This is an enormously dynamic, innovative and creative business, and the people in this town who do this stuff will invent the next idea to be profitable and successful in the environment,” Johnston says. “This is just a great opportunity to focus people on solving those problems and coming up with the right management, HR, service ideas to create the next generation of growth.
“In some ways, this is a gift.”
