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Stewart Dalby: Merger time for the oil sector's minnows

Stewart Dalby: Merger time for the oil sector's minnows
A time for contemplation if you are an oil junior in the current market.

There has been much talk in the oil and gas sector that there will to be need to be around of mergers and acquisitions to avoid the dire consequences of a plummeting oil price.

But where will activity be greatest?  Will it, as in the past, be amongst the majors?  Or will the oil price rout affect the mid-tier groups and small caps. Will the bid for San Leon Energy (LON:SLE) , if it goes ahead, be the first among many?

To look at what might happen now it is worth examining what took place in previous modern day oil price crises.  Wild swings in oil prices can really be dated from the formation of the Organisation of Petroleum Exporting Countries (OPEC) in 1960.

This cartel of producers, notably those in the Middle East, controlled 40% of global oil production and became able to heavily influence prices; and it did just that.

In the early 1980s the Iranian revolution and the ensuing Iran/Iraq war meant greatly reduced output from one of the world’s largest producers - Iran. The oil price shot up to US$35 a barrel - a record then.

OPEC increased output to bring the oil price down. But this was offset by ill- discipline with quota busting by smaller country members. The increase in supply turned into a glut and this sparked off what became known as the Great Oil Price Depression, with prices in the doldrums from 1985 to 2000

One consequence of low prices, which has ramifications for the situation today, was a wave of mergers and takeovers amongst the Majors. BP became BPAmoco, Exxon became ExxonMobil, Conoco became ConocoPhillips and so forth.

The new Supermajors cut down on exploration and this in turn led to a significant amount of new company formation for exploration and development – particularly in the UK, where the North Sea was becoming very active.

The trend for small start-ups of oil and gas companies continued as the oil price rose and there are today 110 companies, broadly defined as oil & gas groups, listed on AIM.

So what will happen now? It is unlikely, in my view, that there will further amalgamations of the majors. 

A recent report from Edinburgh-based consultancy Wood MacKenzie says that energy giants have put the brakes on 45 oil and gas development projects worth US$200bn, which means that economies are well advanced.

It is different for the smaller companies. They do not have much in the way of cash reserves, large staffs to lay off or big projects they can put on hold. Mergers could be the answer. 

Colleague Jamie Ashcroft has written, quoting Citigroup analyst Michael Alsford, that mid-cap companies could deliver between 5% and 15% of extra cash flow by merger. He says Ophir Energy (LON:OPHR) and Soco International (LON:SIA) would have significant overlap given their similar geographical footprints.

Alsford also believes Premier Oil (LON:PMO) and EnQuest (LON:ENQ) would have considerable synergies given their operational overlap in the North Sea and Asia. Kurdistan-focused Genel Energy could combine with Toronto-listed Oryx Petroleum (TSE:OXC), he reckons.

Other small–cap firms are actively seeking mergers or takeovers. Lansdowne Oil & Gas (LON:LOGP) has an ongoing strategic review which could result in a sale. Similarly, Trinity Exploration and Production (LON:TRIN) has said: “We have launched a formal sale process.”

Still other small companies are being stalked or looked at because they appear to be so cheap. San Leon is a case in point. The company has recently received a bid offer and it already has a shareholder – the Toscafund – which has built up a 41.47% stake in the company.

The shares at 62p mean a market cap of £33.07mln. However, broker finnCap says that just taking the near-term production assets in Poland and adding in plus cash it arrives at a core net asset value of 264p a share and has this as its target price.

Petroceltic International (LON:PCI) has also had its admirers. Dragon Oil, late last year, made a takeover bid at 230p before it withdrawing its interest because of the growing uncertainties over oil prices.

Moreover a dissident shareholder, Worldview, which owns 29% stake in the firm tried to gain control of Petroceltic by demanding board changes, but was seen off at an EGM.

The company is dominated by its huge Ain Tsila project in Algeria.  Sarah McCulloch, analyst at RMC Capital Markets, says on the basis of Ain Tsila’s massive reserves, she gets a risked at 75% net asset value of 120p, which is line with her target price of 121p. Petroceltic’s shares are currently 44.1p.

One way or another we could see a lot of activity over the coming months.

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