Episode Transcript
[00:00:00] Speaker A: Now there's a tremendous focus on, you know, what's the strategy behind this company. And now I think if you look across the sector at any, any given company, the successful ones, the consolidated tours, if you will, they have a strategy.
[00:00:15] Speaker B: Welcome to the next Imperative, a podcast hosted by A and M Energy leaders tackling key issues and trends in the industry.
[00:00:24] Speaker C: Hello and welcome to the next Imperative.
My name is Jeff Angulo and I'll be your host and moderator.
Our regular audience will recall a recent episode where Al Karn Wright and Jay Johnson spoke about the shifting landscape in Energy M and A, and that inspired a new series that we're launching with this episode on Energy industry M and A. Joining me for the conversation today are my A and M colleagues and industry thought leaders Julie McLaughlin, Mark Clevenger, and Ken Berendis. Welcome, everyone.
[00:00:55] Speaker D: Thank you.
[00:00:56] Speaker E: Thanks, Jeff.
[00:00:58] Speaker C: Let's jump into the conversation. Some of the themes that Al and Jay spoke about include portfolio optimization, consolidation, of course, the need to replace exploration that really hasn't happened in many, many years and required supply growth for all these companies that are driving a lot of these transactions. And it's really all getting lumped together under the banner of consolidation. Mark, can you start us off and kind of talk about what you're seeing as the major m and a themes on the upstream side?
[00:01:25] Speaker D: Yeah, sure, Jeff. Those themes that Jay and Al spoke about are playing out. We're seeing that both in the major deals going back to Chevron, Hess, Exxon, Pioneer, the Oxy Crown Rock transaction, as well as some of the more recent mid cap deals, including Endeavor and Diamondback, Chesapeake and Swin and Apache and Callan. It's really consolidating around core positions, adding drillable inventory to extend the investment horizon for these companies, as well as creating economies of scale. So each one of those deals has had significant operational synergies announced with them that came from lease operating reduction, capital efficiency, and in some cases, capturing commercial or midstream opportunity through diversification.
[00:02:20] Speaker C: That's not all about GNA synergies.
[00:02:22] Speaker D: Very few of these deals are about GNA synergy.
[00:02:25] Speaker C: Ken, what are you seeing from the midstream perspective?
[00:02:27] Speaker A: Yeah, sure, Jeff. To some extent, I'd say, as goes the upstream, so goes the midstream sector.
Like the upstream sector, we're finally starting to see a wave of pretty significant consolidation in midstream. This level of activity was expected during the last couple of cycles.
Banks gave, but however, banks gave waivers, valuation gaps were pretty wide and management teams and the capital behind them were able to ride through those cycles. This cycle has been different. There was a period of pain in the downturn, but now we have a sector with strong balance sheets, capital discipline and relatively stable equity pricing. And that's all driving confidence in the sector, giving management teams, both sellers and buyers, the confidence to actually do deals. And those valuation gaps are starting to close.
You know, as a result, we've seen quite a bit of m and A in the sector. We're seeing strategic acquirers buying their peers, we're also seeing them buy large asset packages. So it's been a really active market over the past several months.
Private equity, on the other hand, has been forced to sit on the sidelines for the most part. Unless they're sellers, they don't have the synergies. Obviously, that's what the strategic buyers do. They may not have the capital to deploy and they may not necessarily have the support of their lp's that have been under or applying ESG kind of pressure. Although ESG has become a dirty word fairly recently. But generally speaking, we've kind of exited the massive growth phase driven by organic growth. There's been a lot of regulatory pressure, permitting issues. So you're not seeing that kind of large scale build out that you used to see. So strategics have now turned to m and a to drive their growth. So we've seen a lot of public peer consolidation. Just to list a few deals. Energy transfer purchased Crestwood, Sunoco and Nustar, Oneok, Magellan, and then in the compression sector we saw Kodiak purchase CSI. These are all public level deals. We're also seeing strategics by PE backed midstream companies.
Williams purchased Cureton Western, midstream picked up meritage, energy transfer purchase Lotus. So we're seeing a lot of that activity as well. We're also seeing consolidation of ownership in existing assets. So Williams, for example, consolidated their ownership in Rocky Mountain, midstream purchased the interest from KKR, Targa consolidated their interest in Grand Prix and several other assets, and P 66 consolidated their ownership in DCP.
So what's driving all this besides growth for growth sake, some of the strategies driving m and a in midstream wellhead to water is a common theme. And what that means is we see midstream see a tremendous amount of value in owning each piece of the value chain of the midstream sector. So from the gathering system at the source of production all the way to the export facility at the water. And by that I mean gaining direct access to or even owning LNG, indoor crude and NGL export facilities. So that's driving a lot of what we're seeing. And this really enables them to touch the molecule along every step of the way and drive volumes to their existing asset base in order to maximize utilization.
[00:05:55] Speaker C: Fascinating. Ken, what are the strategies that are driving that behavior, that activity?
[00:05:59] Speaker A: Sure, Jeff, there's a few. Wellhead to water is a common theme that we hear. It's basically midstreamers. They see tremendous value in owning every piece of the value chain. So when I say wellhead to water, it means owning the gathering system at the source of production and each piece of that chain all the way down to the export facility on the water. And by that I mean they want direct access to or even own LNG indoor crude and NGL export facilities.
This enables them effectively to touch the molecule every step of the way, but also gives them the opportunity to control the volumes on their system and make sure that they utilize or maximize utilization of their existing assets further downstream and.
[00:06:47] Speaker C: Capture revenue on each value chain.
[00:06:50] Speaker A: Punch a ticket every step of the way.
We also see midstreamers looking to core up and gain critical scale in key basins, for obvious reasons, Permian obviously being the biggest focus, but we're also seeing a lot of activity in Louisiana, south Texas, Oklahoma, which are kind of the next step, if you will, away from access to LNG export facilities. On the gas side of things, storage has been a big focus for the sector, with strategically located high deliverability caverns being the key focus.
And we need that to support Lng export facilities. Also with the high variability of power generation, given the renewable intermittency and renewal variable demand of power generation, particularly with the growth of intermittent renewable power generation.
[00:07:46] Speaker C: Great. Julie, what are you seeing on the clean energy, energy transition side?
[00:07:51] Speaker E: Yeah, I think it's been a dynamic market the last few years. There's been continued m and a activity driven by a number of different areas. I think in particular, there's been a lot of funds raised at the private equity level for energy transition, renewable energy sustainability.
I think the last three years have seen about a clip of 32 to kind of 40 billion being raised at a global level for this space. And I think we felt in the industry that things had kind of slowed down a little bit last year with the interest rate hikes, which have a very direct impact because there's a lot of project financing that goes into renewable assets. However, just looked at the numbers from Bloomberg New Energy finance, and the investments that went into energy transition were about almost 1.8 trillion globally, which was a significant increase from 1.1 trillion the year before. So actually you can always say heuristics can be deceiving. So we felt like things were a little bit slower, but when you actually look at the numbers they weren't at all. They actually increased quite a bit. Where I think we are seeing some shifts is that more recently about the last twelve to 18 months, we've been seeing regulated utilities sell off their unregulated renewable development platforms which were very popular for a while.
And so I think as utilities get more rate pressure and it's becomes harder for them to kind of pass through all of their costs with inflation and interest rates, they're looking to generate cash through the sale of unregulated.
That is a fairly new trend in the last twelve to 18 months.
[00:09:53] Speaker C: Interesting. Where do you think areas of growth or activity is going to continue here in 2024?
[00:10:00] Speaker E: Well I think there's a lot of new areas in particular supported by the IRA and the IJA. There's a lot of funding for new cutting edge technology in green hydrogen and ccus. There's been a kind of a resurgence of interest in renewable natural gas and renewable diesel or biodiesel depending on what you like to call it, which is interesting because that's where I started my career about, you know, almost 20 years ago doing methane abatement projects through renewable natural gas and organic biogas conversion. So it's fun to see it come full circle.
[00:10:43] Speaker C: Neat. Mark, what are you seeing in the upstream side? Where do you think M and a activity is going to go this year? Mark?
[00:10:48] Speaker D: Well I think we're going to continue to see consolidation in the Permian. The Permian is going to, you know, it's the largest oil and gas field in the US and will continue to be that way.
I do think we'll see more consolidation in the Eagle, Ford and Appalachia regions.
I think they're going to consolidate like we saw the DJ do a couple years ago and so we'll exit that with a couple of really large operators that have industrial logic and scale to them and that's what's going to be needed to give them a long term investment horizon.
[00:11:23] Speaker C: So with Appalachia it sounds like we're maybe seeing a shift or a pickup in activity on the gas side.
[00:11:28] Speaker D: Well in the Utica is very oily and so some of the Utica operators have announced some really prolific wells here recently and they're generating great returns. So even with the depressed gas pricing we're seeing now, you're still getting activity in that region of the country.
[00:11:49] Speaker C: Ken, what themes do you see playing out on the midstream side in 2024.
[00:11:53] Speaker A: I think it's going to be more of the same.
It's interesting, there's been so many deals lately that I'll call it the target universe, has shrunk considerably if you look across the midstream sector over the past ten years, but even more in the past few years, the number of companies in this sector has decreased dramatically. I think some would argue that there were too many.
We went through a long phase of, particularly in the MLP era, where companies were formed and cobbled together whatever assets they could just to increase the cash flow profile of the business because they got the credit for it. Regardless of what it looked like strategically, that's all changed now. There's a tremendous focus on what's the strategy behind this company.
So a lot of those assets have been acquired, have been peeled off. And now I think if you look across the sector at any given company, the success, successful ones, the consolidated tours, if you will, they have a strategy and they've been able to pull all their assets together and create a real value chain. So I think you're just going to continue to see that group, the larger consolidators that, again, have the strong balance sheets to go out and good equity to use to go out and continue to build up and core up around their existing assets. So we're going to continue to see that.
[00:13:21] Speaker C: Julie, where have you seen the integrated oil companies investing in clean energy and kind of, what are their drivers?
[00:13:28] Speaker E: That's a good question. I mean, I think at the highest level, their drivers are ensuring their longevity as we go through the energy transition. And I think part of the challenge with the energy transition is that it's a paradigm shift and it's going to take a while. And so there will be bumps in the road.
But I think the future, by all projections, it's clear which direction we're going. And so I think there have been, you know, Iocs that were early movers, and I think they've developed a lot of capabilities, which is really good. But I think being an early mover, you certainly take more risk because it's. It's unclear how things are going to play out. And also, there are certain aspects of the energy transition. For example, power generation has a fundamental different structure than oil and gas. And if you have a molecule and you have reserves in the ground, those reserves have intrinsic value that if, for whatever reason, you're going through a period where prices aren't attractive, you can leave that molecule in the ground. It retains that intrinsic value.
Power on the other side, the kilowatt that you don't generate isn't there for you to pick up later when you have a heat wave in Texas.
It just doesn't exist. And so I think that fundamental difference of the structure, I think, can be challenging to mix with the oil and gas fundamental financing structure for that reason. And I think where private equity has found a lot of interest in power generation is that the assets, especially renewables, solar, wind and storage, have a very long life. They're less maintenance overall, pretty predictable, and you can enter into long term contracts with price certainty and then use leverage. I think where the market still is in for some more adjustment is that as the cost of interest rates have gone up, then leverage has become more expensive. And sometimes you may have inked a power purchase agreement two years ago that is no longer profitable under the current kind of inflationary and interest rates environment. So I think there's some sorting out of that, and I think IOCs are reacting to that. We've seen announcements from Shell, for example, that they're going to deemphasize their focus on energy transition. They have been a heavy investor in renewable power, along with some other areas.
I think there's a very natural fit, certainly in the molecule side. So all of the renewable fuels, the ccus, there's no one better at subsurface than the IOCs and hydrogen, which they're already using for refining other applications. So I think they know better again than anyone how to manage hydrogen. And then it's just a question of where do you get that hydrogen from? Is it from gas or is it from electrolysis using renewable power, what are the major themes?
[00:17:08] Speaker C: Any acquirer and Mark, I'm going to throw this to you first. What are the major themes any acquiring company needs to be thinking about when they're getting ready to sign up a deal, a transaction, what do they need to be on top of?
[00:17:19] Speaker D: Yeah, so pre signing, I think the first thing is, is probably intuitively obvious, but have a very clear investment thesis and understanding why you're doing this transaction, what levers you're going to have to create value through it, and that'll help you make sure that your priorities and interests are aligned in the right direction. And you can then organize the diligence that you're doing around those investment thesis and whatever it is that you have to believe in order to create value through the transaction.
Also, I think that it's never too early to have very thoughtful design work around, and especially in the case of a merger closing or the signing day announcement day is your first chance to make a first impression, and that structure begins to set the foundation for your ability to execute on the synergies in the investment thesis.
[00:18:19] Speaker C: And just as a follow up, where do you see companies often fall short?
When have you gotten the call? Can you help us with this? We've maybe stubbed our toe a little bit.
[00:18:29] Speaker D: The best practice is being able to get out there and tell the employees why we're doing this deal. Be clear with your employees. Be clear with your stakeholders.
You don't want to be playing from behind and trying to explain the rationale after a transaction has been inked.
[00:18:47] Speaker C: So communication plans are key, communication, being ready and getting them out as quickly as you can.
[00:18:51] Speaker D: And I think a lot of times buyers think about what we're going to say after the deal is announced because they're very focused on getting to the deal to close and the confidentiality that's needed during the negotiation process.
[00:19:07] Speaker C: Julie, anything to add?
[00:19:09] Speaker E: I totally agree with Mark. You've got to have a clear investment thesis. I think it also is, is ideal if you have kind of a long term vision. Right. Again, as we go through this energy transition, there are going to be fits and spurts and bumps along the road. And I think the investors and the acquirers that do the best have a longer time horizon and are able to, let's say, ride out some of the bumps rather than, I mean, and we've seen this a lot, I think, across, across multiple spaces, but in particular in energy, where there's a big trend, a lot of acquisition happens. Companies feel like they're behind the ball, so they rush in to make a big move, overpay for something, get penalized by investors, and then have to sell it at the trough, worst case scenario. So you really want to take a long term view and hopefully you have investor support to stay the course so that you have the thesis play out. I mean, I was part of a sale of a portfolio of assets in California right before the resource adequacy payments really shot through the roof. That's like kind of California's capacity market.
And it, you know, I mean, more than like five times the value of a kilowatt capacity per month has gone up since we sold those assets. So you certainly want to be able to ride out those bumps if you have an investment thes. I mean, not all investment theses are perfect, but sometimes they are. They just need a little bit more time to mature.
[00:21:04] Speaker C: Yeah. To get through it.
[00:21:05] Speaker A: Yeah, I guess I would echo some of that. I mean, you need to effectively articulate your strategy. And obviously, your deal ideally is cash flow, accretive, leverage neutral or enhancing, and offers a lot of synergies. And I think being able to capture those synergies early on, well, one, communicate them to the market, but ultimately capture them and effectively integrate the acquisition is our key.
[00:21:33] Speaker D: Yeah. Oftentimes around a transaction, you see activist investors come out and take a position for or against the acquisition or merger, and having an airtight story around the synergies, the value enhancing levers associated with that transaction, and then being able to demonstrate the results after close and give, give line of sight to the, to the value that's being created and synergies that are being realized to the market, well, you'll get rewarded for that.
[00:22:09] Speaker C: And that's where we see a lot of things fall apart, is lots of promises, synergies. Here's what we're going to do, and then the follow through doesn't happen for whatever reason. And it's where I think you can bring in some short term help to make sure, to help track that and make sure that it all happens and really extract the value of the deal you originally intended.
[00:22:28] Speaker E: I mean, everybody has day jobs too, right? That can be, it can, it can be as much identification as a capacity issue.
[00:22:36] Speaker D: Exactly. These are big deals, right? I mean, they're real transactions. They have big implications.
Studies have shown that 70% of m and a transactions don't achieve their intended value.
And so, to your point, Jeff, get focused, get organized around the outcomes that you're seeking to achieve. Have a clear vision and move very thoughtfully and relentlessly through that.
[00:23:08] Speaker C: Make sure you track them and make sure you stay on it. To your point, Julie, I mean, capacity can be an issue, and people are going to go back to the day jobs after having been disrupted, just getting the transaction done. That's really where the effort doesn't need to stop.
[00:23:19] Speaker E: And you want people focused on their day jobs, right? Presumably that's why they're on board, is to do a good job at their day jobs. And that's what ultimately leads to the success of the company itself.
So I think that's important.
[00:23:34] Speaker D: For years, we were in energy industry. We were in a period where capital was cheap and a lot of deals were done about how to put capital to work.
Today is more about returns on capital and capital discipline. And so this operating synergies are more valuable and bigger emphasis of why we're.
[00:23:55] Speaker C: Doing the deal and better paid attention to by the investors after the fact.
[00:24:00] Speaker D: Absolutely.
[00:24:01] Speaker C: You better do what you say.
If you get a call today from one of your clients about to do a transaction, what are some of the leave behinds you'd like to leave with them to be thinking about to make sure that it's successful?
[00:24:12] Speaker A: I mean, I think it's a lot of the things we touched on today.
What's the strategy behind the deal?
Listen, my assumption is when we get the call, they've done the financial analysis behind it, and it's going to have what I call the essential features. It's going to be accretive to them. It's not going to have adverse impact on leverage.
So, yeah, communicate the strategy well. What is the strategy? Communicate it well.
What do you see as the synergies behind the transaction? And how confident are you in your ability to effectively integrate this business? And I'm assuming it's either a large scale asset or maybe a peer that you're going to merge with.
How confident are you in your integration abilities? You know, we've had a lot of conversations with companies that have that confidence, but it hasn't been tested, or we've also had conversations with teams from the target side. And what they've told us is acquire a came in with a great plan, but on day one, but on day two, it all fell apart. So it's key to not only have a plan, but also be able to effectively execute on it.
[00:25:33] Speaker D: Ken talks about having confidence, and I think if you're really convicted in the potential and your ability to execute, you ought to be able to be very transparent with the progress once you've realized to the market. And I think that's one of the areas where, if you look at transactions that recently in the energy space, whether they're upstream or midstream, where the market did not reward that transaction, it was because the synergy story wasn't really clear and crisp, or that the acquirer hadn't had a history of delivering on that. And then in the areas where the market really embraced and rewarded a transaction, the industrial logic was clear to everybody, and the synergy number was really big.
[00:26:28] Speaker A: I mentioned earlier, there was a time where doing a deal just to grow was rewarded to some extent. Those days are over. And there have been some deals where the acquirer did not articulate the strategy and investors were really scratching their heads. Why did they do this deal? There are some large deals that fit that, and you just, again, really need to be able to articulate it and it needs to make sense.
[00:26:56] Speaker E: I would say if it's in particular if it's a company transaction or platform transaction, not just an asset deal, especially the larger ones, are very complex and need a very detailed plan and attention to detail. And so I think not to underestimate, especially to, to Ken's point, and having been both on the buy side as well as on the advisory side of some of these transactions, I think the kind of auction processes from investment banks, you do boil, you start off with a pretty boiled down version of the business on an Excel spreadsheet, and it would be a much simpler world. Probably we wouldn't have a job if everything played out as it was on that boiled down spreadsheet. But the truth is, is a much more complex business underneath. And so I think it's successfully transitioning from that kind of, you know, high level assessment and valuation into the details to make sure that especially in a high cost of capital environment, that you're not losing a couple points on the transition services agreement or, you know, or replacing certain individuals if you're not getting. Sometimes certain teams come along and not others, and sometimes specific teams can be, you know, very scarce in the market and it can be really expensive to replace that kind of capability. So I think really making sure that in that last planning phase that you get is as much into the details.
[00:28:40] Speaker C: As possible and don't be afraid to ask for help.
[00:28:44] Speaker E: That's right.
[00:28:45] Speaker C: Well, thank you. Appreciate all of your wonderful insights to our audience. Thank you for joining us. We hope you join us for future episodes in the m and a series where we'll dive into more details on specific phases of a transaction.
[00:29:01] Speaker B: Thank you for listening. Make sure to subscribe to the next imperative so you never miss a new episode. Also, visit our website at Alvarez and Marsan to learn more and to connect with us.
