Mergers And Acquisition Strategy In The Energy Sector During The Oil Price Drop Of 2014-2016: A Critical Analysis

Mergers in the energy industry

Write a report critically analysing how the strategy of merger and acquisition has been used in the energy sector during the oil price drop of 2014 to 2016. 

Mergers and Acquisitions (M & A) are the change in business composition, ownership, assets and alliance in a particular industry with a core focus on maximizing the profits and shareholders' value. Therefore, mergers and acquisitions mainly exist with an aim of improving the performance of the companies in the industry by increasing profitability and efficiency of operations in the company (Bösecke, 2009 p.30). Also, a merger can be said to the process of combining more than one firm to form one main firm by dissolving the original individual firms to create a new firm (Depamphilis, 2013 p.450). One of the key things in mergers and acquisitions is the boom and strong financial base that exist whenever two or more companies come together to form a new entity. The boom gives the new firm a more strong capacity regarding resources and bargaining power in the market and therefore the new business can do business more efficiently without financial constraints(Kumar, 2012 p.171).

 The success of corporations and their management in attaining competitive advantage heavily relies on the efficiency with which the company carries its merging or acquisition strategy (Whitaker, 2012 P.39). In recent years, there has been increased competition among firms to gain market share, and competitive advantage and one of the strategies that companies can employ in order to gain the competitive advantage is through M & A. This strategy is best especially if a company targets to enter into new markets or expand its capacity to new boundaries (Campbell, 2011 P.67). Therefore, M & A provides numerous opportunities to companies regarding market access, efficiency, financial resources, gaining of expertise that did not exist before, and economies of scale accruing from the process (Whitaker, 2012 P. 41).

"The energy sector is one of the most strategic industries in the world because the industry drives economies in the whole world" (Griffin & Pustay, 2015). Due to the importance of the sector, many investors continue to invest heavily in this sector in anticipation of higher returns, but that is not always the case because of the volatility of the oil prices. The volatile nature of oil prices is attributable to overreliance of oil markets on the prevailing market situations (Griffin et al. 2015).

Internal and external drivers to mergers and acquisitions

Energy sector accounted for more than 30 percent of the total value of mergers and acquisitions as of the last quarter of 2015. "The reason why there is a high rate of M & A in the energy sector is that of declining oil prices as from 2014 up to today" (Griffin et al. 2015) Therefore, companies in the energy sector have resorted to mergers and acquisitions as a major strategy that will ensure they survive in the volatile energy industry. Therefore, there are several internal and external factors that contribute to merging and acquisition in the energy sector.  

In the energy sector, large companies are major focused on the acquisition of more oil reserves so that they may enjoy the economies of scale due to large oil capacities. Smaller companies, on the other hand, are more focused on exploration activities discovering new oil fields which they can invest in and make profits (Leal 2013, p. 69). But most of the small firms focused on oil exploration do not have the requisite expertise, financial resources, and good supplier links through which they can supply their oil. This implies that their reserves remain idle and cannot generate cash, yet they are important assets to the companies. For this reason, small firms accept mergers with large oil companies, or they may decide to sell their assets (oil reserves) to large companies to generate money from their investments (Kumar 2012, p.167).

Energy industry especially oil and gas sector relies on natural resources which are finite in size and subject to depletion due to constant drilling and mining of the oil products. Depletion is thus one major challenge for the oil companies which must be handled carefully if a company must remain operational in the energy industry (Kumar 2012, p.170). Successful companies, therefore, must replenish their oil reserves for them to remain competitive and this is normally done by use of profits earned from the sale of oil products. Most of the companies use the deal making tactic as a means of acquiring proven oil reserves to their assets. Large energy companies avoid the risk of exploration by buying already explored oil reserves that have not been developed by any other company provided they have high expertise and production values to develop the fields (Kumar, 2012 p.168). For instance, most of the acquisitions in 2014 by large companies were through buying of undeveloped but explored fields.

Major acquisition deals in the energy sector

Companies in the energy sector have different core competencies and expertise when it comes to oil and gas exploration. Some are better equipped at deepwater drilling; others are good in horizontal drilling and other companies can carry out deep shale exploration more efficiently (Bösecke 2009). In addition to the technical know-how, some companies are good at research and development. Most businesses desire to have all these competencies so that they can compete more effectively in the industry against other competitors (Corrales & Romero 2012, p.197). Therefore, due to the divergent technical knowhow possessed by different companies in the energy industry, companies resort to mergers so as to have a variety of technical skills and competencies that give them competitive advantages.

Different countries have different modes of taxation, and the policies keep varying from one country to another. Companies in the energy sector conduct their researches and determine the trends in those taxation policies and business regulations and thus make decisions based on anticipated tax regulations (Kumar 2012, p.171). For instance, if oil companies anticipate higher marginal tax rates in future, they rush to make merger deals and acquisitions so as to avoid the fiscal burden in future. This was evident from the 2014 statistics where major deals between companies were struck because most corporations were anticipating a higher tax margin in the first quarter of 2015.

Since the second quarter of 2014, oil prices has been declining and thus affecting many business operations in the energy sector (Financier Worldwide, 2016). However, the M & A in the energy sector remained steady in the second and fourth quarter of 2014 but in 2015 the merger and acquisition deals reduced which affected the sector significantly (Financier Worldwide, 2016).

In April 2015 Energy Transfer Partner (ETP) acquired Regency Energy Partners in a deal worth $16.47 which was one of the major acquisition deals in 2015. In this deal, Regency Energy became a wholly-owned subsidiary of ETP and therefore the assets belonging to Regency were acquired by ETP (Depamphilis 2013, p.450).

In June 2016, Vermilion Energy Inc purchased production and exploration assets from Engie E & P Deutschland, and the deal were worth $47.9 million, and this is a great step ahead in the company's operation.

The deal between White Star Petroleum LLC to acquire Woodford Shale assets that were initially owned by Devon Energy. Another deal is that of HRG Energy Corporation sale of its oil and gas business to CPP WI Holding Company.

Benefits of mergers and acquisitions

Sanchez Energy Corp. sales 50 percent of its assets to Sanchez production Partners at $7.4 million. The total deals in 2015 picked up after a slow start to hit a record of $3.2 trillion as of the fourth quarter, and this was a major boost in the energy sector. 

Even though oil and gas are similar products across the world whose price is globally determined, but the market dynamics are complicated to understand and therefore a critical analysis of the market segmentation and reach is important (Kumar, 2012 p.140). Most consumers of oil are sensitive about the quality of oil and gas that they consume because of increased awareness of environmental conservation and desire to avoid environmental hazard risks. Acquisitions have helped companies to locate their oil and gas plants at strategic places in the world where they know they can maximize profits by charging a premium price (Kumar, 2012 p.191). The acquisition has also given large oil companies access to the quality pipeline, refineries, good markets and better transport which have increased their efficiency in operations.

M &A deals reduce the costs of administration and governance because in a merger there is less administrative fees and some production increases with fewer personnel. A good example is a merger that was formed between Quantum Resources and Breitburn in 2014 where the two firms combined and the estimated synergies were $23 million during the first year of merger formation. Most of the companies that formed mergers in the year 2015 reported a reduction in administrative costs by approximately 50 percent, and this is all attributed to mergers and acquisitions by companies in the energy sector.

Mergers are large and financially sound companies that enjoy a better treatment from authorities in public markets (Kumar 2012, p.171). Better treatment is evident from the way 2015 mergers were treated. For instance, Whiting Petroleum Company moved to acquire Kodiak Oil and Gas and from the time the company made the acquisition its financial strength and business relations with other companies has greatly improved. When Energy XXI’s acquired EPL Oil & Gas in 2014, the company witnessed a total transformation and management of the company attributes the success of the merger to their economies of scale (Gold 2014, p.303). Therefore, mergers and acquisition strategy employed by enterprises in the oil energy sector plays a critical role by giving companies economies of scale to do more businesses with other partners despite the dropping oil prices.

The acquisition strategy gives companies access to new locked up markets that are more profitable. The performance of any company in the energy sector depends on the markets in which the company operates and most of the high-return, high-quality plays in the energy sector is already held up by large companies (Fraunhoffer, 2013). Therefore, if a company wishes to gain core acreage in such plays it must have a well-calculated strategy on how to enter the mature plays of which leasing is almost impossible. The only available option for obtaining acreage is through acquisition, and therefore large corporations in the oil industry continue to use acquisition as a strategy to obtain land in the most profitable markets (Fraunhoffer, 2013). Two companies are good examples where acquisition strategy was used to obtain acreage into new profitable plays. Encana acquisition of Athlon Energy in September 2014 gave the company an entry into a new Midland basin also allowing it to shift production mix towards oil (Fraunhoffer, 2013). Also, Noble's acquisition of Rosetta Resources helped the company to gain access to two new plays enabling the company to increase its profitability. Therefore, companies in the energy sector have used acquisition strategy to gain access to new profitable plays without which they cannot because most of the core areas in new plays are leased to host companies that have consolidated them (Gold 2014, p.78). Therefore, for a new firm that wishes to enter these core areas with high rate of return, it must use acquisition strategy.

Gain of technical expertise with ease. Companies use acquisition strategy to gain technical expertise when entering new basins because for any entrant the challenge is normally the steep learning curve regarding the manner in which wells are drilled and operated (Kumar, 2012 p.167). Companies gaining access into new basins using acquisition strategy reduce development costs and maximally use the existing wells because they use already existing employees and resources from the existing company (Kumar, 2012 p.171). Furthermore, the new company does not need to negotiate new contracts necessarily because most employees retain their previously signed employment contracts, and this eliminates the learning curve that is always costly.

During the process of acquisition, companies sometimes purchase other entities in foreign countries with entirely different regulations from the first regulations existing in their host countries which must be complied with for the company to operate legally (PwC 2016). For instance pollution laws and regulations differ from one country to another, and these laws might impact negatively on the company's profits because sometimes it is quite expensive to obtain pollution license from authorities in some countries (Carstensen & Farmer, 2008 p.89). Therefore, as much as mergers and acquisitions is a good strategy for companies in the energy sector, some government policies are a stumbling block to the success of those mergers (PwC 2016). A good example is China where the country wants sustainable energy sources while at the same time reduce pollution and therefore all mergers operating in China must comply with pollutions regulations (Knodt & Piefer, 2016, p.143).

Management of infrastructure and capital projects under mergers is also a big challenge. Most oof the merging companies have large established and ongoing capital projects and infrastructure that must be well handled lest they collapse (Doern & Eberlein 2009, p.24). In 2015 separate companies in the energy sector invested approximately $4 billion into new projects and this figure is quite high which implies that if companies form mergers, they must be ready to overcome the challenge of managing such massive projects with little conflicting agendas. Sometimes also, it is a challenge for companies forming a merger, yet the two companies have different or conflicting growth strategies that require compromise to reach an agreement (Gore, 2013 p.72).

Human capital challenge: when companies merge there is a high possibility of difference cultural clash because the two companies come together with employees having different cultural views and organization. It takes time for the management of the new merger to integrate these employees fully into one unit with a common culture and agree to the new terms of service (Hitt, Harrison & Ireland, 2001 p.38). Some key employees who are very strategic in companies opt out of their positions as a result of mergers because they feel their authority and influence in the company is threatened, or they feel they will not be adequately appreciated (Hitt et al.  2001 p.38). This is a big challenge to the new management because they need to shift their focus from concentrating on the core business of the merger and start focusing on retention of key employees.

Litigations arising after a merger is formed also poses a great challenge to companies. Environmental liability and site clean-up may cause the newly formed company to be sued by locals and other stakeholders in a law court because the initial company may have a litigation against it which is then transferred to merged corporation (Findlaw, 2016). Sometimes when forming a merger, oil companies do not fully disclose their assets in the form of reserves because reserves in the form of hydrocarbons have not yet been produced yet the law requires that all the information about reserves must be disclosed (Findlaw, 2016).  

Conclusion

Mergers and acquisitions in the energy sector have become a major strategy by most companies as a means of dealing with the ever dropping oil prices in the global market. Since 2014, the number of mergers and acquisitions in the energy sector has been increasing globally with the majority of the mergers targeting to gain access to new profitable markets. Other drivers of mergers and acquisition include obtaining of proved reserves, taxes, and regulations and development of new oil fields. Companies that use merger and acquisition strategy gain new highly profitable plays, geographic diversification, better treatment by governments and other business partners, and technical expertise thus eliminating the learning curve. Despite the many benefits that accrue to mergers and acquisitions in the energy sector, mergers face challenges of litigation risks, human capital cultural differences, management of large capital projects and legal compliance challenge.

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