Lured by significant upside potential, vast numbers of attractive opportunities for investment, and ample cash and funding, financial investors spent nearly $245 billion on upstream energy transactions during the past decade, with their annual transaction activity increasing six-fold, according to new analysis from information, analytics, and solutions provider IHS Markit (Nasdaq: INFO).
The new IHS Markit study identifies financial investors as commodity trading firms, diversified conglomerates, financial service firms, government entities, hedge funds, investment firms, pension plans and private equity firms.
Despite the fact that global upstream M&A activity in terms of overall deal count and deal size has been down during the past two years due to the oil price decline, financial investors have sustained their investment activity in the energy sector, the IHS Energy report says. During 2006 to 2015, financial investors participated in energy transactions across the entire investment spectrum, including asset and corporate level M&A, private-equity funding, loans for oil, privatizations, and investments in private E&P companies.
As a result, financial investors currently account for more than one third of global upstream transaction value, and IHS Markit expects their participation in the sector to increase in terms of both deal activity and transaction values. One of the key reasons for the increased activity by financial investors is the increased activity of private-equity firms, which is driven, in part, by increased allocations to alternative investments such as private equity by pension funds and other long-term institutional investors.
“Financial investors have significantly expanded their investments in the upstream E&P sector because they have numerous opportunities to invest, plenty of available capital, and they are keen to take advantage of the opportunistic acquisitions that arise during oil market downturns,” said Cindy Giglio, CFA, senior financial analyst and author of the IHS Markit analysis. “We expect this trend to continue, since they can afford to go bargain hunting for deals that have significant upside potential when oil prices improve, and they also see the sector as a very attractive outlet for longer-term investments. They can better afford to sit on those investments and wait for greater returns.”
Additionally, there are currently numerous available upstream opportunities and IHS Markit expects financial investors to continue their major role in upstream energy M&A, in part, “because they have had difficulty finding other attractive equity investments outside the sector that are fairly valued with compelling upside potential in the current environment of low interest rates,” Giglio said.
According to the IHS Markit Analysis, an estimated $165 billion in upstream asset opportunities are currently available, based on the IHS Energy Significant Energy Assets on the Market Database, which Giglio expects will continue to drive financial investors to favor the sector. Nearly half, or 45%, of these upstream opportunities are located in the United States, mostly diversified and unconventional assets such as tight gas, shale gas, tight oil and shale oil. An additional 19% of those assets are located in Africa and the Middle East, with 10% located in Canada and 9% in the Far East and CIS.
These available opportunities are actually being understated, Giglio said, because the IHS Markit analysis did not include ’rumored’ sales nor planned energy divestitures by large integrated oil companies totaling more than $75 billion.
The IHS Markit report also said that, in addition to an ample supply of upstream opportunities available for investors, there is an abundance of money available for funding those investments. “In the quest for higher returns and greater diversification of risks, target allocations for alternative investments have been increasing to 35% or more of these investors’ portfolios,” Giglio said. “Those alternatives include hedge funds, private equity, real estate, direct oil and gas investments, timber and more. As private-equity investments in oil and gas have grown and been successful, more money has been raised for new private-equity investments. Currently, industry estimates of private-equity ’dry powder’ capital that is assigned specifically for investment in the energy industry to be as much as an estimated $100 billion to $150 billion.”
Over the past decade, the S&P 500 Energy Sector Index has underperformed all of the S&P sector indexes except for financials; on a worldwide basis, energy equities have also underperformed. Although energy equities are priced aggressively versus current commodity prices, the IHS Markit report said they are valued more attractively relative to other equity investments. Should oil prices rebound, energy equities could be an attractive investment opportunity for financial investors.