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Last Updated: March 21, 2016
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You’ve probably heard the saying “buy low and sell high” or some version of it. Oil prices have been painfully low, so does that mean it’s time to buy physical oil assets?

The shale boom in North America over the past 10 years has brought many potential buyers through our office looking forConsulting support. The allure of high returns, large drilling inventories and capital flexibility can be tempting. Many buyers who struggled to stomach the valuations of the assets when oil prices were high are now revisiting the space thinking there may now be a number of great deals to be had. That’s where we start exerting a bit of caution with our clients as there is no magic formula or time – given a bit of hindsight, the landscape is littered with “bad deals”.

Most people thought last year was going to be the year of opportunity in the deal market, but operators proved resilient and lenders demonstrated patience and flexibility. Fast forward and more than a year of low prices is putting some operators in sticky situations. The best deals (for the best assets) make sense at almost any oil price, but there’s no doubt it’s better to buy when the sellers have to sell.

We believe a buyer’s market will emerge if low oil prices persist (there are likely great deals happening now and we’ll see them announced over the next few months). But generally speaking, the sellers who are forced to divest assets do not have much exposure to the best acreage, and those who do will part with their best assets only as a last resort. Outside of relatively small “bolt-on” asset deals, we expect corporate M&A to be the preferred entry vehicle for companies entering core areas.

Companies come to us after they’ve started the process and we generally help them get better organized and more focused in their search. Most haven’t considered all the consequences. They want an asset that meets all or most of the following criteria:

  • Financially stressed
  • Top-tier acreage
  • Low-risk future development
  • Exploration upside
  • Cash-flow positive
  • Good price or valuation

In short, they’re looking for a unicorn – that is, an asset someone else has discovered or purchased before really knowing what they had. For the most part, companies don’t sell these assets. They’re the crown jewels.

And although you can’t buy another company’s crown jewels on the cheap, investing in upstream properties can still be a good option.

These days – with the amount of liquidity looking for deals and a wealth of publicly available data to analyse performance – it would be hard to buy something that is materially undervalued by the rest of the market. Well, unless you’re willing to take exploration risk.

Executing the transaction isn’t the first step. We start by asking a few basic questions:

  • Financial commitment: This is the “what’s-your-budget” question in home-buying terms. It also involves more than the upfront acquisition cost. If you want the asset to grow, it’s going to take significant reinvestment over a long period of time (you’ll be on the capex treadmill for awhile).
  • Materiality: Is your budget big enough to make a difference? It sounds fun, but it could just distract you from your core business, whether it’s focused in another region or in a complementary business (trucking, refining, chemicals etc.).
  • Risk tolerance: Are you willing to buy in an up-and-coming neighborhood? Exploration success rates may be low, but the payout could be big. Are you willing to risk hundreds of millions with a baseball-batting average chance for success or do you need barrels today (hint: producing barrels are more expensive)? Another reason unconventional drilling is favored is the failure rate is low. You might lose money, but dry holes or absolute failures aren’t common.
  • Timing: Do you have to buy something being marketed today or do you have time to build relationships with potential sellers? Note, the best deals typically aren’t publicly marketed, whether it’s needing to raise cash or it’s a seller that doesn’t want the deal hitting the public domain. You want to be the buyer when the deals are negotiated quietly.

Even if a company can get internal agreement on these issues above, the most important element is its capability. Does it have internal strengths and infrastructure that will help it execute or does it need to acquire the talent through a corporate acquisition?

That’s just the beginning of the process. The answer to our original question isn’t as simple as most people hope but, in our view, it is much more important to identify the right deal as opposed to a good deal. Check the weather before you fly, the timing might be right or you might be flying into a storm.

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