- Implications of the Statoil and Norsk Hydro Merger
- A Changing Industry Landscape
- "A Beautiful Sight, We’re Happy Tonight…"
- Capex Survey Suggests a Tale of Two Markets in 2007
- Employees Want More Than Dollars
- Connecticut Electricity and NIMBY
Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies. The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations. Allen Brooks
Implications of the Statoil and Norsk Hydro Merger
On December 18, Statoil ASA (STO-NYSE) and Norsk Hydro (NHY-NYSE) announced plans to merge their offshore oil and natural gas units in a $30 billion deal. The transaction, which is likely the last mega merger to be announced in 2006, will create the world largest offshore oil operator based on number of barrels of production. It will create the fifth largest European oil company based on stock market capitalization. The big question is will this merger be the first of many over the next several years in response to changing industry conditions, or is this deal unique and driven primarily by internal company and Norwegian government considerations?
Exhibit 1. The New Combined Statoil
Source: Statoil, Norsk Hydro
Combined, the two companies expect to produce 1.9 million barrels per day of oil equivalent in 2007. They also should have proved reserves equal to 6.3 billion barrels of equivalent oil. The bulk of the reserves and production of the new company are in the Norwegian sector of the
Exhibit 2. Combined Statoil and Norsk Hydro Operations
Source: Statoil, Norsk Hydro
Why this deal, and why now? There are many possible reasons, but in our mind the principal ones are the increasingly competitive nature of the global search for new hydrocarbon reserves, cost pressures in the companies’ existing exploration and development projects and the need to jump-start reserve and production growth on the Norwegian continental shelf. The merged company will control roughly 70% of the oil and gas production on the Norwegian shelf.
We examined the information about drilling in the Norwegian sector of the
The profile of total petroleum production for the Norwegian shelf shows a near-term peak last year with the possibility that production may be elevated to a new peak over the next several years, but then the basin embarks on a steady decline beginning about the end of this decade. The large Norwegian oil companies (the parties to the merger) have demonstrated a declining spending profile in
Exhibit 3. Outlook For
Source: Bente Nyland, NPD presentation,
The petroleum tax law changes the Norwegian government has implemented have improved the attractiveness of oil and gas exploration for new entrant companies. The primary changes include providing for the reimbursement of the tax value of uncovered losses from exploration activities, the ability to carry forward the tax value of losses when a company stops operating and the acceleration of the credit against the special tax for new petroleum investments. These changes have improved the certainty of the fiscal regime for these new entrants along with boosting the profitability of investments, especially for increased oil recovery efforts. The changes also have enhanced the value of licenses that should make them easier to trade.
Exhibit 4. Licenses Awarded in Norwegian Shelf Mature Areas
Source: Bente Nyland, NPD presentation,
The impact these tax changes have had on new activity is best demonstrated by the increase in new licenses in mature producing areas by new entrants and small and medium-sized companies. The success of the effort is further demonstrated by the fact that new entrant companies are stepping in and drilling more, thus helping to pick up some of the slack in drilling by other companies. Attracting new companies is important to revitalizing the Norwegian petroleum sector, especially if the government hopes to boost future production. One has to wonder, given the emerging trend of greater participation by new entrant companies, whether the government will push for the new Statoil to disgorge some of its unexplored acreage holdings and even existing field ownership interests. Those moves could help accelerate the push for greater new entrant involvement in the Norwegian sector.
Exhibit 5. New Well Drilling on Norwegian Shelf
Source: Bente Nyland, NPD presentation,
One of the reasons given for the Statoil/Norsk Hydro merger is the ability of the new company to reduce future operating costs. The companies are careful not to make too much of this point because of the sensitivity in
Exhibit 6. Norwegian Exploration Expenses 1995-2005
Source: Bente Nyland, NPD presentation,
The history of costs in the Norwegian sector are tied to the generally industry activity cycle. As shown in Exhibit 6, the cost of exploration has risen and fallen in concert with the overall ups and downs of the global petroleum industry. Exploration costs were extremely high in the recent boom years of 1997-8 only to decline in the following years as the industry went through a mini-recession. Costs were up in 2001, again in response to a tighter E&P market and they jumped significantly in 2005. While we have not seen the data for 2006, we suspect costs have risen further as drilling rig contracts day rates are up substantially along with the prices for almost all other oilfield products and services. Getting costs out of the system has to be an objective of the merger, along with improving the ability of the new company to compete internationally in basins with greater potential that require lower cost structures to be profitable.
Countering the pressure to reduce costs will be the thrust of the oilfield service companies. Other producers in the Norwegian sector will be fighting the market dominance of the new company. By controlling roughly 70% of production and having accounted for nearly 70% of all the wells drilled over the past six years, the new Statoil has a disproportionate share of the Norwegian offshore market. If the company is allowed to continue to operate as it has in the past, then
The Norwegian oil workers union has weighed in against the merger, largely because of the exclusion of worker representatives on the board from the negotiations over the terms of the deal. The leader of SAFE, the onshore and offshore worker union, Terje Nustad, said. “This is a coup; it is a new oil revolution and a new development. Statoil should focus on the NCS.” Arild Theim, a spokesman for the Industry and Energy Union said he was concerned about the status of the new company with respect to the number of new exploration and production licenses awarded compared to the number the companies would have received individually. He said, “The land-based supply structure should be kept on as it is today…so that the merger does not lead to job losses.” However, he did say that the union viewed the deal positively, especially the increased state ownership as it should help to prolong the life of the Norwegian shelf. In addition, the new merged company will be a stronger player in the international oil industry.
The upshot of these comments suggests the sensitivity the unions have to possible job losses due to cost considerations, but what they are also concerned with is the potential for a reduction in the market position of the new company within the Norwegian sector. The dilemma posed by union concerns – possible job losses and reduced future work opportunities – versus the government’s concern about stimulating E&P activity on the Norwegian shelf shows the challenge of making this transaction a success.
A recent article in The Wall Street Journal suggested that the merger of the two Norwegian companies is a sign of the times and that big oil companies are preparing for a new wave of consolidation. The premise of the article was “that bigger companies will better compete in the world’s increasingly crowded oil fields.” According to the article, the big oil companies are struggling to add oil and natural gas reserves and production and are facing increased competition and tightening access to hydrocarbon resources around the world. By getting bigger, these large oil companies will be better able to handle those pressures. The article then went on to postulate that a merger wave could result in less industry capital spending dimming the outlook for the oilfield service industry.
We agree with certain aspects of that thesis, but not all. Clearly the global hydrocarbon market has become more competitive. The introduction of more state-owned and state-sponsored oil and gas companies with access to their government’s coffers into the industry struggle to acquire hydrocarbon reserves and production has unleveled the playing field. Unfortunately, that genie is out of the bottle and not likely to be put back in, so the competitive landscape is different this time, and more importantly will remain different.
Interestingly, the issue of reserve and production growth for the major oil companies has been largely ignored by Wall Street and investors who appear to be more focused on stock valuations based on per share metrics. By repurchasing shares and achieving modest E&P success, oil companies have been able to maintain, or even increase, their per share metrics, which has led to higher stock prices, although higher commodity prices have been a driver, also. Most of the big oil companies have not meaningfully stepped up their capital spending efforts. Rather, they have used their huge cash flows to boost dividends, buy back shares and pay down debt. Despite these expenditures, most company cash flows have overwhelmed this spending leading to buildups of cash on the balance sheets.
While the oil companies appear to be well-positioned to finance acquisitions, we doubt the upcoming wave of industry consolidation will resemble previous ones. The acquisition wave experienced in the 1970s and early 1980s was driven by company efforts to get bigger, or to fend off takeover attempts. The deals done in the late 1980s and 1990s, however, were almost all driven by cost-reduction needs.
What are being talked today are deals driven by growth considerations. While a different strategic reason for consolidation, an important consideration that may shape this merger wave, at least for U.S.-based oil companies, will be the attitude of the new Congress. The initial thrusts from the anti-profit, new congressional leaders will likely be increased pressure on the oil companies to lower their refined product prices, i.e., cut their profit margins, and to boost their spending on alternative energy investments. We suspect that any moves by major oil companies to buy other
Given our view of the M&A landscape for oil and gas companies, we think the thrust of consolidation efforts by U.S.-based oil companies will focus on foreign companies.
At the end of the day, the shifting petroleum industry landscape will further pressure oil company executives to step up their capital spending as the only realistic way to deal with their ballooning cash flows and growing cash hoards. Financial engineering steps (boosting dividends, buying back stock and paying down debt) can only address this cash issue at the margin. Reinvesting in the business is critical, but most managements fear opening the spending spigot just at the wrong time. Shaking that fear will be difficult, but the pressure to do so will likely grow as we move through 2007.
A Changing Industry Landscape
Without betraying or compromising our sources, we thought the anecdotal information we have learned over the past two weeks suggest that our antenna should be attuned to a changing industry landscape as we move into 2007. Some of the information suggests that people swept up in the “boom mentality” stimulated by high oil and gas prices may be paying the price for having bet on those prices continuing in the face of weaker prices and signs of a softer economy next year. Other data suggests that managements are re-examining their company business strategies in light of actual or perceived changes in the industry and/or political landscape.
We understand several small U.S. E&P companies are close to defaulting on bank loans and have held discussions with bankruptcy lawyers as a result.
We also have been told that several Canadian oil and gas income trusts have laid off employees to deal with lower commodity prices, escalating oilfield costs and the higher cost of capital due to the tax law changes.
Some energy company lead tenants for new real estate projects in
Certain international oil companies are re-examining prospects in geographic regions they have shunned for years because their access to more attractive global E&P markets is being restricted.
Is any one of these data points the equivalent of the canary in the coal mine? No. But collectively, they raise warning flags and signal that anyone predicting a continuation of recent industry trends will probably be wrong. Change is underway. Figuring out how much change, and in what ways it will happen becomes our challenge.
“A Beautiful Sight, We’re Happy Tonight…”
Last Wednesday night, my wife and I drove to our daughter’s home in Keller, which is northeast of
Exhibit 7. Barnett Shale Play in
Source: IHS, ConocoPhillips
At one point on the road there were lighted drilling rigs on the horizon all around us. The view took me back to a time in the early 1980s when I hosted an investor energy conference in
Capex Survey Suggests a Tale of Two Markets in 2007
Recently the Lehman Brothers’ oil service and drilling research team, headed by Jim Crandell, reported the results of their survey of oil industry exploration and production spending for 2007. The results were in line with what many analysts had been expecting – the end of the run of double-digit annual spending percentage gains.
According to the study, Lehman Brothers’ estimate of worldwide spending, based on its survey of 299 oil and gas companies, calls for spending to increase in 2007 by 9% to $292 billion. By region, international spending leads with an increase of 13% to $196 billion, while
In reading through the study, we were drawn to several issues behind the thinking of the oil and gas companies as they approach setting their budgets for 2007. The two issues we found most interesting were: 1) the key determinants for E&P spending; and 2) the most important technologies. Each of these topics were measured over the 2000 to 2007 period and the changes in their importance points to shifts in oil and gas company thinking about their businesses and what they should be doing about it.
Exhibit 8. Key Determinants for E&P Spending 2000-07
Source: Lehman Brothers
As Lehman Brothers pointed out in its narrative, natural gas remains the key determinant of E&P spending in 2007 reflecting the heavy concentration of North American independent producers in the survey. Because of this bias, cash flow, prospect availability and drilling costs are also important considerations. What we find interesting is to look at the ranking of these determinants and how the percentages have changed over time. For example, natural gas prices, at 53% of respondents, are barely above the 2005 level when this driver was ranked third on the list behind cash flow and oil prices. Over the period 2000 to 2004, natural gas prices led or were tied for the lead on the key determinant list. While the importance of natural gas prices has declined somewhat, they have been the prime driver for E&P spending for virtually all of this decade.
For all the concern expressed by producers about oilfield services inflation, the ranking of drilling costs at 37% for 2007, and its relatively low ranking throughout the period suggests that high commodity prices way outweigh cost concerns. Interestingly, drilling costs were rated higher in both 2005 and 2006 and was much higher in 2002. This year’s figure suggests oilfield inflation has peaked.
We were also intrigued by the low percentage for capital availability. That determinant stands at 28% for 2007, which has to reflect the growing cash flows from high oil and gas prices and the vast amounts of public and private capital available. Bank loans to oil and gas companies has begun to grow significantly as lending officers believe the outlook for the industry is solid for the long-term. Historically, when commercial bankers fall in love with an industry because of its solid fundamentals, we are often close to a tipping point in the outlook. Will it be different this time? No one knows.
Turning to the most important technologies survey question, for the first time in the eight-year time period 3-D/4-D seismic lost its premier position to fracturing/stimulation. This change reflects the growth in developing unconventional gas reserves and their need for fracturing and stimulation to improve the hydrocarbon flow from these reservoirs. In third and fourth places are horizontal drilling and directional drilling technologies, respectively. To our way of thinking, these two technologies are so similar that they should be combined, which would put them in second place behind fracturing and ahead of seismic technology.
Exhibit 9. Most Important Technologies
Source: Lehman Brothers
What is very interesting is the position of reservoir recovery optimization technology. As can be seen, it has come from nowhere in 2002 to effectively fourth place on the list of most important technologies. However, this technology is still quite low in overall importance. But then again so are almost all the other new technologies ranked lower on the list, some of which appear to have significant future potential. Once again, the dominance of small North American producers among the surveyed group probably has skewed the answers to the most important technologies question since they are more heavily focused on exploiting unconventional gas resources. Also, fewer companies are targeting deepwater technologies and intelligent well completions. This bias does not invalidate the responses to the survey questions, it’s just that the bias needs to be remembered when reading the results.
Employees Want More Than Dollars
Cheryl Collarini of Collarini Energy Staffing recently appeared on a panel at Hart’s Energy’s first Recruiting and Retention conference and discussed the results of a survey her firm conducted on non-monetary issues important to energy company employees. She was surprised by some of the findings. The survey assumed competitive compensation for all those surveyed. The universe of employees surveyed tended to be largely professionals that may have swayed some of the results.
According to the survey, the number one issue across all ages and genders surveyed was the company’s reputation. This is an important consideration for management and should be factored in to all corporate decisions. Following that as the next most important issue was challenging work. This is not totally surprising as workers enjoy and are stimulated by challenging and varied work rather than monotonous and boring tasks.
The next group of important issues all involved the people and the culture at the company. These issues included the team, the supervisor, the ability to influence decisions and the openness to new ideas. These are important considerations, but are very personal issues. The next most important issue had to do with personal time, which included the length of commute and flexible work hours. These two issues would seem to go together as the ability to manage one’s hours may improve commuting time. These issues also explain why companies are often more willing to consider relocation when their existing office lease terms expire, even though there is a huge cost associated with a shift. We are aware of companies that when considering relocating conducted employee residence surveys to aid them in their relocation decision.
Surprising to Cheryl Collarini, the least important employee issue was assistance with child and elder care. This result may be due to the level of professionalism of those surveyed. Those employees probably believe they can and should be able to handle these issues outside of their work environment. Another panel member who represented an industry with many more lower paid positions found that it was able to improve retention of employees by adding child care facilities. In this age of tight energy labor markets, paying attention to the non-monetary concerns of employees may make for more stable labor forces, which clearly is a cost-saving strategy.
Connecticut
Politicians are much more optimistic about
The council is charged with determining the rules and regulations for power and telecommunications services in the state. As part of its charge, the council is to review long-term electric power forecasts and recommend actions to ensure adequate future supply. In the new 2006 report, the council forecasts that
In preparing its forecast, the council considers the forecasts prepared by the three major electric power companies operating in the state and examines their plans for maintaining and expanding power generation capacity during the forecast time period. Additionally, the council also has to consider the potential retirement of generating facilities due to their age.
A consideration within the forecast is the diversity of fuel sources in generating power supplies. Currently,
The more telling point of the analysis is the council’s review of the ability of
The council concludes: “To adequately address
Dominion Nuclear Connecticut Inc., the operator of the Millstone Unit 2 and Unit 3 nuclear power generation plants, recently made some modifications to the plants that have increased their generating output by 16.4 megawatts, or 0.8%, without increasing their fuel consumption. Earlier this year, Connecticut Attorney General Richard Blumenthal had proposed a “windfall profits tax” on the Millstone plants. This misguided attack came in response to the ratcheting up of electricity costs in the state due to most of the power plants experiencing rising fuel costs. The beauty of nuclear power plants is that their operating costs are very low, however the capital investment to build them is huge and the construction time is long.
A recent article in The New York Times highlighted the rise in
What we find most fascinating about the
The preferred solution for
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Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.
