Write a report critically analysing how the strategy of merger and acquisition is used in the energy sector during the oil price drop.
The entire gas and oil industry was in a complete shock when everyone has to face the cost and cash flows pressures. The 18-month long collapse of oil prices have led to mergers and acquisitions from all the four sectors that is upstream, oilfield, midstream and downstream (England and Slaughter 2016). Moreover, the impact in oil drop has not only affected the viability of short term but also influenced the investments and the long-term objectives. The wave to reshape the energy industry when oil prices hit the energy sector led to one response that is mergers and acquisitions. This strategy was widely accepted to bring stability while improving the situations of the companies so that they could access the new markets (Joshi and Desai 2015).
This research highlights the sharp decline in oil prices in the past years and the help that had been provided by mergers and acquisitions to the small producers to enable them to earn profit in the external as well as the internal environment. The oil price volatility constitutes to be harmful as it results in fluctuations in output growth leading to uncertainty for future prices. The study will analyze the oil drop and the effectiveness of the mergers and acquisition in different companies to analyze the process while redefining the sector.
Merger and Acquisition in 2014-2016 during Oil Drop
The oil drop in 2014 has been from the peak price of 115 US billion dollars per barrel in June 2014 to approximately 50 US billion dollars per barrel in 2015. The reduction in prices of oil added with the continued low natural gas prices has declined the number of operations in rigs affecting the drilling commitments to more than 250,000 professionals (Krauss 2016). On the other hand, when we consider according to the sectors then the downstream had been benefited while widening the refining margins for falling feedstock rapidly. The midterm sector had been providing cash flows based on the pipeline transportation fees whereas the prospects seemed to have slow down the upstream sector.
Many companies resorted to mergers and acquisition strategies because companies with low economic outlook could not achieve the growth strategy. However, this strategy was adopted by the organizations to strengthen the technical and financial base that could reduce the cost structures. Conversely, mergers were for that company where the corporations combined their share of resources with a common objective whereas acquisition was done for the small corporations where the organization took a legal subsidiary or the selected assets of the firms. This strategy adopted yielded benefit to give wealth maximization to the shareholders (Joshi and Desai 2015). However, adopting this strategy lowered the pressure on both the buyers and the sellers.
The financial investors have been significant in maintain a consistent presence in the energy value chain such that the investors are mainly focused on establishing their upstream with larger capital needs or complex assets. Although, there has been growth in mergers and acquisitions since 2015 and the certain examples that deals with more complex investments include companies like Hutchison Whampoa’s that acquired a stake in Husky Energy for 2 billion dollars followed by Macquarie’s Stake Brookfield and Asset Management hold a stake for 2.1 billion dollars in Apache Energy (Atkearney 2016). Moreover, the largest merger deal between BP and Royal Dutch Shell cannot be fruitful for the oil drop scenario because the deal and the operations are fiendishly complex and regulated (Crooks 2014).
Mergers and Acquisitions Outlook for 2015
The industry oil and gas experienced a wave of mergers and acquisitions providing a decisive action towards the oil prices stabilization. It started with notable acquisition of 82 billion dollars of BG Group by Royal Dutch Shell. In the first quarter, here were a total of 100 million dollars value mergers across 40 deals. Among the non-oil and gas entities, most deals were focused downstream including Qatar’s 5 billion dollars acquisition in Shandong Dongming Petrochemical as well as SamrukKazyna of a stake of 49% and JSC’s 4.7 billion dollars investment in KMG Kashagan BV with a stake of 50% (England and Slaughter 2016).
However, the opportunistic as well as consolidated acquisitions was required to provide a competitive edge that not only restructured to emerge stronger than before but also meet challenges, specifications on time. Conversely, the small service oil companies became targets for creative financing so that that valuation gap could be structured with considered limitations on the viability. This was possible through by using derivative instruments to create options for stable cash regarding fees as well as forward discounting.
Mergers and Acquisitions Outlook for 2016
The consistent scenario in reduction in oil prices ensured liquidity to be one of the imperative factors such that in early 2015, Exxon, Chevron, BP and Total issued a debt of worth 31 billion dollars in raising cash through secondary equity. However, to meet the ongoing deal structures of the organization, there had been job cuts in the international oil companies that comprised of 7,000 job cuts by BP, creating headcount reductions as a measure of cost reductions (Atkearney 2016). Hence, the oil companies had to use more transformative measures like competitiveness of high-grade portfolios. BP, Chevron and Shell announced 45 billion dollars sales over the next few years focusing on sustainable assets to meet the reduction in oil prices.
The model that can be used for external environment is PESTEL whereas the model that can well describe the internal factors are the Porter’s Five Forces. However, the strategy for market development based on mergers and acquisitions can be studied using Porter’s Generic Strategies.
PESTEL (External Factors)
The external factors highlight the business environment for the external environment. The strategic analytical techniques that can be used to evaluate the impact of external factors on the adoption of mergers and acquisition during the oil drop is PESTEL.
• Political Factors
The political events that had led to decrease in oil drop was majorly because of the war or rebellion that had struck the oil producers and prevented to produce or sell oil such that the supply of oil reduced. The side effects are known to be as “resource curse” because of the geopolitical politics and political instability. Moreover, the changes in the oil production is due to the collapse of oil prices that remain to be stagnant since 2014 levels (Pitatzis 2016). However, the slumping down of global demand and a glut of global supply is still making smaller or larger companies struggling to cope with the energy sector’s doldrums. Politically, all the global companies as if Shell plunged sold extra 10 billion dollars assets to plunge 87% of profits. Halliburton and Baker Hughes abandoned its tie up of 28 billion dollars. On the other hand, to meet the cost structures in the political environment, BP had done 1 billion dollar cuts including job cut as a response to oil prices. Comparatively, though BP has strategic partner Statoil that agreed to sell a portion to for 740 million dollars (Atkearney 2016).
• Economic Factors
The economic environment has equally in a turmoil after the drop in oil prices from 115 US billion dollars per barrel to 35 US billion dollars per barrel at the end of February 2016 (Rogoff 2016). The oil sector was not able to hold anymore of spending of projects as the supply exceeded the demand (Austin 2016). The following diagram below can explain the latest imbalance in supply and demand.
Moreover, the differences in prices has been prevalent due to the global economic crisis. Although, the world economies had been recovering from the crisis but the extraction from the unconventional and off shore gas fields led to high cost of extraction amongst the reserves. The other reasons that added to these economic factors were over mounting of public and private debt in OECD countries and shadow banking system in emerging economies (Pitatzis 2016).
• Social Factors
The socio-cultural factors that played a role in the reduction of oil prices includes migration, demography, income, culture, religion views on issue. The social trends that significantly affected the oil and industry are the reduction in the usage of fossil fuels like oil sands, shale gas and coal and opting for alternative sources of energy. The loss in jobs during the aftermath of crisis and in the period of 2015-2016 resulted in negative attitude of the people towards larger companies (Austin 2016).
• Technological Factors
The technological factors that laid the foundation for the oil drop are the risks that can be associated with the access to rare resources that enabled deep-water drilling in cash rich industries. Such operations have not only increased the danger but also have provided barriers in upgrading to a new technology (Pitatzis 2016).
The innovation market may pose risk from exploration leading to software innovation from the unlevelled ground that may lead to extreme costs in the oil and gas industry.
• Environmental Factors
The medium effects of low oil prices depend on the environmental sustainability of biofuels causing unavoidable competition in food production and providing restricted greenhouse gas benefits. Moreover, the energy prices in 2013, have been straining public finances. As a result, there are countries that redirect pollution to environment and public health as most of them lack carbon prices that could reinforce structural change to lower carbon economy. Moreover, the basic environmental reason that led to the low oil price is the nuclear incident that took place in Fukushima Japan and the Hurricane Karl because of which various wells had been shut down in Mexican Gulf (Krauss 2016).
• Legal Factors
The legal factors that briefly describe the reduction in oil prices is due to the certain taxes and tariffs in the notable capital and labor that has not only discouraged the economic activity but also has also worsen the future economic growth. On the other hand, the reduced subsidies had been undertaken to balance budgets in the economies. However, the transitioning to a competitive workforce has not only made the oil producing countries one of the least productive countries but also entailed the freedom to enterprise their families. OECD receives the only benefit as lower energy prices create an opportunity to reduce fossil fuel subsidies while providing wide range of economic benefits like tax breaks, opening up political space for reforms, etc. (Baffes et al.2016)
Porter’s Five Forces (Internal Factors)
The internal factors can be analyzed based on the microenvironment of the various organization that had been driven by the cause and effect of the reduction in oil prices.
New Potential Entrants – The new entrants will have benefit to enter in the market in the form of mergers and acquisition that will lead to potential lucrative markets, as there would be government backing for drilling. Moreover, Cuadrilla’s position, as one of the organizational in the UK oils and gas sector will improve. On the other hand, shale gas market will be uplifted.
Industrial Rivalry and Competitiveness – The industry rivalry and competitiveness is low because the growth of the organization has fallen to a level where market share can be taken from other firms based on mergers and acquisition. However, as there is strong market for oil the standardization could be maintained.
Power of Buyers – The organization and OPEC hold a large market for oil and gas buyers stating that the power of buyers will be high and the market demand will rise, as there storage for airlines and haulage will increase.
Power of Suppliers – The power of supplies will be considered medium, as there will be many oilfields from where the oil extraction could be done. However, due to extraction in unconventional farms, the competition might exist between Baker Hughes and Schlumberger (Evans, Nyquist and Yanosek 2016).
Threat of Substitutes – The threat of substitutes will be higher for oil and gas industry because the only substitute available is renewable energies that comprises of biomass, solar, wind, geothermal and water. Although, the demand for renewable will be lower in comparison with lower prices but the effectiveness, viability and efficiency will be enable to replace traditional fossil fuels to an extent keeping in mind the environmental concerns (Klevnäs, Stern and Frejova 2016).
Porter’s Generic Strategies
According to the Porter’s Generic Strategies, the economies as well as companies after mergers and acquisitions have adopted the portfolio expansion strategies in the oil and gas industry. The onshore producer have been seeking operations by operating on the unconventional oilfields for shale oil basins. Although, with diversification in the oil and gas industry they are implying cost leadership strategy so that there could be economies of scale and scope after the mergers and acquisition and the organization can make some profit. However, the companies have a first mover advantage in both cost leadership and diversification strategy through mergers and acquisitions. Conversely, there is a need to climb the learning curve in the process to enable players to low cost deals that could be prove to be most valuable in the volatile oil price world.
Challenges and Benefits of Mergers and Acquisitions
According to the merger and acquisition strategy, the organizations will benefit from the deal as the International Oil Companies (IOCs) will survive the intense cost structures but this strategic alliance can drive cost synergies to some extent. Secondly, mergers and acquisition will help the company with healthy balance sheets to get opportunities on advantage account while others will define strategies to survive. Thirdly, the mergers will help the distressed companies to capitalize through mergers and acquisitions such as Schlumberger’s acquisition of Cameron that expanded on offerings to complete drilling to production by joining in-house basin technology with Cameron’s support and external technologies. On the other hand, oil service companies will be hitting hard for consolidation. Moreover, mergers will be beneficial in reshaping competitive landscape as well (Wilson and Turaga 2016).
The challenges that the IOCs will be based on the following factors. Firstly, in terms of failed mergers there would be due on overpayments with the expectation to expand. Secondly, the IOCs might face integration issues like Halliburton Hughes merger failed due to the scrutiny based on European and US regulators on the overlapping business segments, as it did not succeed in selling businesses due to low prices. Thirdly, the selection of the targets and motives needs to be in need of the financial motives and needs (Joshi and Desai 2015). Lastly, the three levels that could affect the strategic alliance are the recovery in oil prices, policy, tax, regulatory changes and availability of capital (Slaughter and Yee 2016).
To conclude, it can be said that although the period of 2014-2016 faced drop in oil prices but the only way the bigger companies could survive was by selling their assets and small companies getting into mergers. However, many mergers and acquisitions took place in the International Oil Companies (IOCs). Moreover, the mergers and acquisitions entered in the market to create win-win situation but depending on the scenario from a longer perspective it was done to cut costs, cope up with the competition and lead to growth in the business environment.
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