October 14, 2016
Interviewed by: Andrea Heisinger
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Why Timing is Everything in Today’s Energy Market

As low oil and gas prices persist, energy companies and potential private equity buyers are in a standoff. EY US Energy Transactions Advisory Services Leader Mitch Fane outlines the perils of a PE buyer jumping in too early—or waiting too long—to look at energy assets to purchase.

As low oil and gas prices persist, energy companies and potential private equity buyers are in a standoff. EY US Energy Transactions Advisory Services Leader Mitch Fane outlines the perils of a PE buyer jumping in too early—or waiting too long—to look at energy assets to purchase.

Why Timing Is Everything in Today’s Energy Market
With Mitchell Fane of EY

Q1: How are buyers and operators in the upstream space handling the continued oil price decline?

Mitch Fane, EY:
I think if you look back at the low commodity-price cycle, the first reaction for many of the producers was that they really tried to batten down the hatches. That means they were minimizing all their capex and drilling, they were trying to live off of their hedges and conserve cash, in the hopes that there would be some type of quick rebound in the commodity price. I think as the cycle expanded and they realized that it was going to continue even further, you started to see many of the E&P independents go into bankruptcy so that they could financially restructure their balance sheets.

We’re now in the midst where there’s somewhere north of 70 companies that have gone into bankruptcy to do the financial reorganization. There are still many companies that have lived through the summer that are starting to think about operational restructuring, which means once they’ve cleaned up their balance sheet, how do they look at the rest of their operations and optimize those operations to continue and survive in a lower economic environment with low oil prices?

Q2: What are energy asset prices like and how are they impacting buyer/seller interactions?

Fane: It’s a pretty sophisticated market where buyers realize that…because it’s a commodity, you have to buy when the cycle is low, so there are lots of buyers coming into the market to acquire assets. At the same time, sellers are sitting there looking at long term price curves, and they’re hoping that they can survive the short downturn to the point that the commodity recovers, and therefore they would not have to sell.

So, for companies that can survive, they’re not interested in selling, they’re trying to batten down the hatches and get to the recovery. They’ll probably not do a lot of transactions or sell a lot of assets, right? But the companies that have been forced to go into bankruptcy because they’ve run out of cash and liquidity will be in a position that they have to sell to someone else that can then operate the assets. We’ve started to see some activity as these companies enter bankruptcy and have started to emerge. As more companies emerge and they go through this financial restructuring, we’d expect more assets to come into the market.

Q3: What would be the impact of buying energy assets too soon?

Fane: The fear is that you buy some assets or a business that really doesn’t have enough liquidity to survive until the economic recovery occurs. So, you buy assets and, unfortunately, you end up going back into bankruptcy. Or, more likely, you end up jumping in and you buy. Then, you end up holding it for two or three years before there is a strong recovery and you’re in positive returns. So, there is this healthy tension of being in the market, of looking at assets and of trying to be one of the first movers to get in and to acquire those assets.

Q4: What are the consequences of waiting too long to buy assets?

Fane: The first thing is there are a lot of buyers out there, right? You would start getting some price tension where other bidders may come in and bid it up before you could actually get into the market and acquire those assets. So, it’s missed opportunity. The other healthy tension to that is that if commodity prices will remain flat to modest for many years, the uptick or the gain, if you will, of acquiring those assets in the downtime is pretty thin. Timing is absolutely key.

Q5: Why are energy operators turning to PE for capital over banks?

Fane: You have very specialized private equity that likes to invest in upstream, midstream and downstream. They understand the assets and understand the asset classes. In upstream, in E&P, several regional banks and even national banks are very focused and have a very heavy asset allocation into energy as well. What you’ve seen, though, is with the rapid decline of commodity prices—$100, $130 down to, in some cases, $30 to $40—their borrowing base shrank dramatically. That put a lot of pressure on the banks when they were going and having discussions with their regulators about their capital adequacy, meaning are the assets that they’ve made loans on sufficient collateral for the loans that are outstanding to the banks?

Again, the other thing [is that] private equity is fairly sophisticated around energy, so it’s a natural bridge for private equity to come in and help finance some of these transactions. They also have a lot of capital available to do it.

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