Firstly, oil prices stabilized in the low $50s for Brent and the high $40s for West Texas Intermediate (WTI), as the US Energy Information Administration (EIA) announced that US crude stocks had fallen by 3.3 million barrels in the preceding week. While historically still high, stocks are down a whopping 72 million barrels since late March, when they peaked at 533 million barrels. The devastating Tropical Storm Harvey will doubtlessly result in significant upward pressure on crude as well as product prices in North America.
Secondly, two major upstream mergers and acquisition (M&A) moves were announced: French supermajor Total agreed to buy the upstream assets of Maersk in a $7.45 billion deal, in the largest North Sea takeover in a decade, while mining giant BHP Billiton confirmed plans to sell off its costly US shale fields. The beginning of last week also brought news that Rosneft and partners including Trafigura Group had finalized a $12.9 billion purchase of India’s Essar Oil.
The upstream transactions are a manifestation of two factors.
Firstly, the low oil-price environment led international oil companies (IOCs) to cumulatively cancel around 40 percent of their scheduled investments in 2015 and 2016. The upstream sector needs constant investment in both production as well as in exploration for new fields, because fields have a limited lifespan and contain a finite amount of oil.
Given the current dearth of investments, it was sensible for Total to acquire producing assets that can immediately be slotted into its own operations. This is because the time span from finding a field to production ranges from three to 10 years for conventional oil.
Total has come under scrutiny for purchasing mainly North Sea fields. Its CEO Patrick Pouyanné argued that the price was right and that US shale assets were, in his opinion, currently overpriced. It will be interesting to see how other oil majors feel about these levels, when BHP Billiton concludes the sale of its shale assets.
The business model of integrated oil companies proved itself during the period of low oil prices in 2015 and 2016, because the downstream segments — refining and marketing — were more profitable than upstream. The aforementioned sellers are predominantly upstream players and the buyers or potential buyers will probably be integrated companies. The Essar transaction does not contradict this argument, because it gives Rosneft refining capacity in India and a foothold the country’s lucrative downstream market.
Big mergers and acquisitions have historically taken place just as the oil price reached inflection point.
The second factor behind the uptick in M&A transactions is that, while oil prices are still relatively depressed, we can see the light at the end of the tunnel. Earlier this year BP’s CEO Bob Dudley pointed out that oil markets are balanced on a day-to-day basis. The Joint OPEC-Non-OPEC Ministerial Monitoring Committee (JMMC) came to the same conclusion during its meeting on Thursday last week. The reason prices are so sluggish is the huge inventory overhang, which will take time to abate. Given demand patterns and with current or even marginally higher production levels, these oil stocks will come down; the International Energy Agency (IEA) forecasts a rise in global oil demand of 1.5 million barrels per day for both 2017 and 2018.
This year has so far been kind to big oil. Whereas there were several profit warnings last year, all the supermajors performed well during the first six months of the current year, generating positive cashflow.
Historically, the big mergers and acquisitions in the energy sector have taken place just as the oil price reached inflection point. BP acquired AMOCO and ARCO in 1998 and 1999 respectively; and Exxon completed its purchase of Mobil in 1999. The late 1990s were a time of extremely depressed oil prices. The commodity even fell below $10 for a short while. The 2000s however brought about the commodities super-cycle, leading to the oil price soaring to $150 a barrel in 2008. The picture today is probably not going to be this rosy, but we might just have seen the worst of the current cycle.
• Cornelia Meyer is a business consultant, macroeconomist and energy expert. She can be reached on Twitter @MeyerResources.