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Oil’s Rise Lifts Energy M&A Hopes

15 March 2016 in Trading Ideas

Key Takeaways

  • A possible merger between TransCanada and Columbia Pipeline may portend a rise in energy deals.
  • Distressed smaller companies may tap M&A options to avoid bankruptcies.
  • Motifs mentioned: Energy Takeout Targets
  • Stocks mentioned: TransCanada Corporation (NYSE:TRP), Columbia Pipeline Group Inc (NYSE:CPGX)

Expectations of heightened deal-making among energy companies this year hasn’t exactly come to pass, but a resurgence in oil prices appears to have convinced investors that activity may shift into gear.

Two large companies in the sector may have just signaled the thaw. Late last week, The New York Times reported that TransCanada Corporation (NYSE:TRP) has been in talks about acquiring US peer Columbia Pipeline Group Inc (NYSE:CPGX) in a deal estimated worth $11 billion.1

Columbia’s share price immediately jumped nearly 9%. Like many companies in the energy industry, however, Columbia’s stock has plummeted in the last year as oil and natural gas prices crashed 60% since the middle of 2014.

Pipeline companies like Columbia, which were once seen as immune from the slump in commodity prices because they carry the oil or natural gas rather than drill it, have been hit in the last few months.

The volatile share price has made consummating deals in the energy sector more difficult as well, the Times noted, with the expected flood of mergers turning into more of a trickle as M&A activity fell 11% in what was otherwise a record year for takeovers.

As a Reuters column pointed out last week, bankers at the HIS CERAWeek energy conference in Houston blamed the lack of activity on high debt levels and valuations that were still too high relative to expected crude prices.2

Of course, TransCanada likely has its specific reasons for deal-seeking. The company recently had its Keystone XL pipeline plan nixed by President Obama, while another big project intended to move oil across Canada has become enmeshed in red tape. These developments may have prompted the company to decide the company would be better off buying pipelines in addition to building them.

However, with oil hanging below $35 a barrel during much of the last two months, a growing number of distressed companies have been warming up to the idea that they might need to sell all or part of their operations to avoid bankruptcy, according to Skip McGee of energy-focused advisory firm Intreptid Partners.3

“The mood has changed significantly,” McGee told The Financial Times recently. “With oil prices around or below $30 a barrel, it’s a whole different situation from a year ago.”

Access to equity and non-investment grade debt has been cut off for most companies, and financially strained companies are running out of options, the FT reported.

Meanwhile, the FT said that private equity firms have raised tens of billions of dollars to invest in US energy, and some deals have been announced recently. Earlier this year, a large area in the Permian Basin of west Texas was bought by a new business called Luxe Energy, which is backed by private equity firm NGP Energy.

If M&A activity in the US oil industry does finally start to take off, it would show that the restructuring has begun.

“Because there was so much capital available, some of those guys were able to hang on much longer than they should have,” Dennis Cassidy of consulting firm AlixPartners told the FT.

A pick-up in M&A would be “a positive sign that recovery is well on the way.”

While oil at $30 a barrel was seemingly flashing a buy signal, the market was still working through billions of dollars plowed into US shale oil frackers, M&A attorney Robert Profusek told CNBC earlier this year. “Before we get to that, there is a lot that needs to come out of the system. There is $100 billion of high-yield debt that was raised in the last five years for frackers.”4

Now, however, oil prices are fast approaching $40 a barrel, and shares of some publicly traded drillers that looked highly overleveraged last month could double as oil rallies into the $50 range by the third and fourth quarter, Eric Nuttall, portfolio manager at Sprott Asset Management, told CNBC.

Indeed, investors have been bidding up the shares of energy stocks, including small- and medium-sized companies that could be attractive targets. The Energy Takeout Targets motif has gained 28.2% in the past month. In that same time, the S&P 500 has increased 8.4%.

Since the motif’s creation last July, it has fallen 52.5%. The S&P 500 is down 2% since July 1, 2015.

Nuttall said he sees an oil market currently oversupplied by roughly 1.5 million barrels swinging to undersupply as the US and other non-OPEC production falls off significantly in the face of spiraling capital spending.

He noted that capital expenditures across the industry are down about $200 billion in 2015, and said they could fall another 20%-30% next year. Without new spending, drillers will presumably be unable to maintain current crude output.

That could mean even higher oil prices, further buoying the optimism that could lead to a surge of energy-company buyouts.

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  1. Leslie Picker and Ian Austen, “TransCanada Is Said to Show Interest in Buying Columbia Pipeline,” nytimes.com, March 10, 2016, http://www.nytimes.com/2016/03/11/business/dealbook/transcanada-is-said-to-show-interest-in-buying-columbia-pipeline.html, (accessed March 13, 2016).
  2. Kevin Allison, “Spring forward,” breakingviews.com, March 10, 2016, http://www.breakingviews.com/mooted-$11-bln-gas-deal-signals-energy-ma-thaw/21238707.article, (accessed March 13, 2016).
  3. Ed Crooks and James Fontanella-Khan, “Obstacles hold back US oil sector M&S,” ft.com, Feb. 21, 2016.
  4. Tom DiChristopher, “’Shotgun weddings’ in energy to boost M&A in 2016,” cnbc.com, Dec. 31, 2015, http://www.cnbc.com/2015/12/31/shotgun-weddings-in-energy-to-boost-ma-in-2016.html, (accessed March 13, 2016).