Outlook for the Energy M&A Market

Hi, Mike. Thank you so much for joining me today.

Mike Giffin:

Thank you for having me, Elana. It's great to be here.

EMS:

Absolutely, Mike. So, to kick off the conversation, tell us a little about yourself, your background, and your practice area here at EisnerAmper.

MG:

Yes. As you mentioned, my name is Mike Giffin. I'm a managing director with EisnerAmper based out of our Dallas office. Most of my 30-year career has been focused on tax and financial reporting valuation for public and private companies, and most of that career during that time, it's been focused on energy sectors, and that takes up most of my time. While it's not my major per se, in terms of spending a 100% of my time, it is most of what I do. And within that energy sector, I've worked across a broad spectrum of different industry verticals, upstream, midstream, downstream companies. I worked with lots of oil field services companies, petrochemicals, metals and mining and power renewable companies. So here at EisnerAmper, I continue to focus on bringing an exceptional team of professionals across a broad range of audit, tax, outsourcing, and advisory services to my energy clients.

EMS:

Great. Mike, given your background in the energy space, I would love to hear your high-level outlook to kick off today's discussion.

MG:

Yeah, and happy to do so. And again, the energy market, the energy sectors have, there's a broad range of those as I just mentioned. I'll touch on some of those. Not every one of 'em in terms of the broad overview, but specifically the oil prices are hovering around $85 a barrel. They're below $70 a barrel in December and as high as $93 in September. But we all remember the $100+ a barrel back a few years ago, as well as when the bottom dropped out, and they were almost worthless back in 2020. Gas prices also back in June of 2022, they were as high as $25, but now they're hovering in that $2-$3 range. And again, so the market demand for that type of energy has continued to keep prices low. And then the LNG prices, the $6 to $7 range, one back a year ago is around $11 and so that continues to be depressed as well. We also see in the ESG energy transition, carbon capture, net zero emissions is kind of a big theme that we're seeing along with battery storage, hydrogen as well as a lot of the wind, solar, hydro, and biofuel spaces where if it's sustainable, reliable, large oil companies are doubling down on their near term fossil fuel bet, just given the expected slow rate of evolution of the power space. So, what we're seeing is an increase in international demand as well across all sectors and some of the themes that we're seeing there that tend to be categorized in some areas of geopolitical uncertainty in Russia or Ukraine as well as Israel, Gaza, and even Venezuela.

But also, another theme is the emergence of new technologies, whether that's new technology for operational efficiency, whether it's new technology as it relates to renewable space and green energy. It's definitely something that's been a theme.

Also, macroeconomic environment is definitely a big driver in a theme in the space as it relates to interest rates, inflation, also policy and regulatory initiatives, everything from net zero emissions, the IRA, which is the Inflation Reduction Act, and the pause of LNG exports as it relates to the current pause from the Biden administration. And then also, last but not least, is the political effects to the industry and just mentioned policy and regulatory initiatives, clearly the U.S. elections this year will affect that. So those results I think will drive much of what's going to happen in terms of momentum in the space as we close out this year and enter next year. From a broader M&A standpoint, what we're seeing is we're seeing a lot of earn out provisions that have increased in recent deals really is just to bridge the gap between buyers and sellers and the current volatile market. And then from a private equity standpoint, we're seeing a ton of dry powder hitting marks close to $2.7 trillion. So, we expect to see the M&A market gain some additional momentum after the election.

EMS:

Great. Mike, let's take a deeper dive into the upstream energy space. I would love to hear your insights on how that has recovered since commodity prices bottomed out in 2020.

MG:

Yes. Yeah, the upstream energy space definitely has had its ups and downs in the last few years. Really, some of the themes behind the upstream oil space is the capital constraints and labor shortage. Labor shortage I think is not just in the upstream space, but across multiple verticals. But also, OPEC expects to their influence on oil prices, but they expect to reduce production in the next year or two. And there's higher premiums being paid in M&A deals for future drilling inventory and reserves. And how this is different is transactions in recent years have focused on current production and profitability, EBITDA, et cetera, with future inventories being less of a focus. But what we're seeing is now they're tending to look at what's down the road, what's available, what reserves are there, and they're willing to pay premiums when those inventories are there. Also, debt capital providers are hesitant to provide capital to the upstream space, nothing new. We continue to see that. So, those who are providing capital to the space are getting creative in how they do that. And then deals this year for the upstream companies, we're already seeing Diamondback purchase of Endeavor for $26 billion, as well as Kimmeridge looking to buy SilverBow for close to $2 billion as well. From a forecast of volume and production, they're forecasting around 3% increase in volume growth with expected increase of reduction around 7%. And then specifically as it relates to some Basin activity, the Permian M&A activity has been really high as public E&P companies are looking for additional drilling locations to support the equity market growth expectations. So, this is similar to what I mentioned earlier in terms of the focus on what's down the road rather than what's exactly being produced today. So, you see a lot of the majors sweeping up a lot of the smaller E&P companies as they're running out of the Tier 1 drilling locations in all basins.

So, you've seen transactions such as the Chevron acquisition of Hess, Exxon's acquisition of Pioneer, Denbury’s acquisition of Earthstone, as well as Oxy and TGNR'S acquisitions as well. So, while deal flow is down 31% from in the last 12 months from 291 to 200, we've seen an increase in the size of these deals from total in the last 12 months from $55 billion to $191 billion, so significant increase there, about 240% growth in that space.

In the upstream gas space, there's definitely oversupply and low prices and a labor shortage, as I mentioned, is also in the oil space, but also almost a 100% increase in the EBITDA multiples as well. So that's something unique for the space, but it's something that we are seeing in the market multiples, and the M&A seems to be more defensive and more focused on cost synergies and cashflow creation. But we are seeing in the LNG markets as well, I mentioned the pause on the LNG exports by the Biden administration. Clearly, I think that's going to be in play until after the election is done, and we know who is in office as we go forward, but we're seeing a high LNG demand due to geopolitical risk overseas and continue to see interest in exporting LNG overseas. But again, even in the LNG market, the focus has been on cost efficiency.

EMS:

Mike, are these same market dynamics being observed in the midstream energy space?

MG:

Yeah, so there's a variety. Some of those are yes, to answer your question, they're strong M&A activity do the increases in the commodity prices. So, in the midstream space, where your pipeline space for both oil and gas, as demand increases, you're going to see an increase in the flow and the increase in business and in M&A activity in the midstream space. So, we saw about 30 midstream transactions in 2023, we're seeing continued consolidation in that space as well, and including about a 10% drop in EBITDA multiples from 2023 from 11 times to about 10 times your LTM EBITDA. So again, I mentioned the pause on the approvals of the LNG exports, so that's definitely going to affect this midstream space as we go forward. And they're all linked together at some point. There's some influences that affect more than others, but definitely here as the amount of business from the standpoint of oil and gas flowing is definitely going to affect the midstream space.

EMS:

Mike, could you touch on deal activity for oilfield service companies? It seems as if it's declined over the last few years. I'd love to hear your insights on what the future of the space looks like.

MG:

Yeah, yeah. I've done a considerable amount of work in this space with small, medium and large size companies that work in the oil field services space. Domestic rig count is down, and they've had a slower rebound than the E&P companies due to the lag. And what I mean by lag is there's a lag between as demand and as the oil rigs continue to come back online and they continue to increase the CAPEX expenditures on their drilling activities, that's when you'll see about a 12-to-18 month lag for the OFS services space in terms of their services and revenues picking up. But we are expecting not only in the next year, but probably the next two to three years, an increase in rig count expectations for 2024 is for E&P spending to be low double digits for the foreseeable few years.

So, CAPEX spending and rig count are your leading indicators in OFS space. So, we expect to see those increase. So, we expect to see an increase in the OFS activity and revenues within the players in that space over the next three years. On the EBITDA multiple front, we saw about a drop of 30% in the last 12 months from about 12x to 8.5 for the oil field services companies. But again, deals are picking up in this space. We've already seen 11 in 2024, or excuse me, for the year of 2023, and we're seeing that picking up in 2004 as well. So, kind of the themes as we go forward in this space really the focus is on cost efficiency in the space. As activity has been declined over the last few years, it focuses on cleaning up the books and coming up with technologies that are more cost efficient and they're using such things as there's a big increase in the use of robotics in oilfield services space as well, partly to support that not only efficiency, but also keep up from the standpoint of the high technical abilities of these oilfield services companies to provide services to their customers.

EMS:

Mike, the elephant in the room for energy companies has been ESG. I would love to hear your insights regarding ESG and energy transition in the renewables and broader energy spaces.

MG:

Yes, it's funny, ESG, the energy transition, the carbon neutral efforts, there's a lot of it that's synonymous, although it doesn't mean the same, but at the end of the day, there is a big push in the industry across the broader energy industry into renewables and green energy. And one of the big things fueling the movement into that it is ESG from high level standpoint, but from an investment standpoint, it really comes down to the IRA, which is the Inflation Reduction Act, which is really, they're expecting about a $3 trillion investment in the space over the next several years. And it's production tax credits, investment credits for those in the space and those even outside the space to get involved and to invest dollars into these industries. There's about over 200 deals in the private equity renewable energy space in 2023 that represented about $19 billion of value, so significant activity in the space.

And so clearly what they wanted to do with the IRA is actually coming to fruition. However, what they are realizing is that although there is a push to really get into the green energy space, that the green energy, many of the green energy solutions are probably not as reliable, at least currently. And because of that, there is a balance or there is a little bit of a tap the brakes in terms of expectations on how quickly we're going to move to green energy and renewable energy sources as we go forward. So, this energy transition to renewal to renewables will take a few decades. So, EIA forecast 85% of new grid capacity additions through 2030 will be new renewable energy capacity or battery storage. But yeah, it's going to be a few years before we get to that point. In the solar space, I'm from Texas and so know a lot about the Texas space, at least as it relates to the renewables.

Texas now tops California for utility scale solar energy. So, there's been sizable investments here. It's now the fastest growing energy source in Texas and four times more solar power capacity coming online than we had in the past and 10 times more than natural gas projects on a go forward basis. And the wind space, Texas has a recent rise in the wind energy projects as well and still is the top renewable in Texas, although solar is catching up. Battery storage as well as also growing at rates similar to solar in Texas. But at the end of the day, the M&A markets for those M&A markets to be opportunistic for industry players and investors, we prefer movement cyclicality. And so, we expect to continue to have plenty of that as we move forward and seeing the movement in the market and the investment from a renewable standpoint.

EMS:

Mike, I want to thank you so much for sharing your insights with me today,

MG:

And thank you very much for having me, Elana,

EMS:

And thank you for watching this. Visit eisneramper.com for more information on this and a host of other topics.

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